Why is it important to pay attention to your shareholder agreement or operating agreement during business formation and throughout the life of your corporate entity?  How can these documents prevent business disputes down the road?

The first contract and one of the most important agreements for a California corporate entity is the “operating agreement” (LLC) or the shareholder’s agreement (S corporation, C Corporation or other corporate entity).  These important business contracts establish the relationship between the owners of the business: the members of an LLC or the shareholders of a corporation.  They address central issues such as the calculation and distribution of profit or earnings, voting authority, as well as how the company will survive major events in the lives of its owners such as divorce, personal bankruptcy, death or incapacitation.

The Shareholder Agreement or Operating Agreement should specify how much each interest in the company is worth, and how that value is to be calculated (the process of valuation).  These decisions are much more easily and effectively answered in the beginning of the business formation process, when all parties are excited and working together cooperatively for the good of the company, than down the road in the midst of a crisis.

What happens to the company when one of the owners is faced with a crisis of their own?  Placing mechanisms into the Shareholder Agreement or Operating Agreement which address these critical issues prevent litigation down the road.  They allow the corporate entity to continue operating regardless of what is happening in the personal life of one of its owners.  These contractual agreements ensure that all parties clearly understand and will abide by specific strategies that will allow the individual to make choices based upon the unique circumstances in their lives, without affecting the smooth operations of the business itself.

Pro-Tip: “The company documents, if you choose a corporation, are quite different.  Not all corporations are the same. If you choose a limited liability company, if you choose a partnership, a limited liability partnership, there’s all types of different variations. And then you can get into the nitty gritty based on your profession and all the regulations and all the professional license requirements and, depending on the kind of company, their resale license and permits. There’s all kinds of little things that your old business lawyer knows about and can tell you about from the get go. As opposed to you finding out after you’ve made a few mistakes,

This process is a lot more than just picking an entity.  You’re giving birth to a living creature that’s been recognized by the United States Supreme Court. And so you have these corporate documents – the shareholders agreement or operating agreement – and you have to decide on how much ownership will cost and who owns what. Then you decide about what potential ownership options there are, such as reserve shares, other ways in which people can own it. And then you capitalize it. Either you capitalize it with cash or you capitalize it with goodwill or a combination or a property. But how you capitalize it can determine whether or not it’s a real company or you have all those protections of corporate veil and creditors and you’re personally shielded. So how you start out and getting the corporate documents carefully tailored to your unique business is very important. And thinking about it, we’ll send you on the right path to avoiding all kinds of pitfalls and trouble.” – Dan Watkins, Founding Partner

If you are forming a new LLC or corporation in San Diego, or have used boilerplate or downloaded forms for your Shareholder Agreement or Operating Agreement we invite you to review our podcast Episode 3 – Corporate Documents and contracts as well as the strong recommendations of our clients and contact the Watkins Firm or call 858-535-1511 for a complimentary consultation today.

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