Maintaining a clean and tidy house is the foundation for successful home life. When everything is in order, things operate smoothly. A privately held business must also keep its “house” in order. But what does that mean?
Every company should have certain vital documents in place to steer it in the right direction, avoid legal pitfalls, guide it through disputes, and establish the corporate veil that protects owners from exposure to personal liability. The information in these documents is also critical for positioning a company for sale, raising capital, and complying with lender requests.
Despite the benefits of having founding documents in place, in advising hundreds of private companies, I consistently find that key documentation was either never created or is outdated, incomplete, or missing.
In many companies, the legal department’s job is to ensure that the house is in order. In others, that responsibility falls to the CFO, relying on outside counsel for help. It’s a task easy to overlook. Still, it shouldn’t be. Failing to have critical documents in place, up to date, and easily accessible can increase risks and hamper growth opportunities.
A privately held company should have the following documents at the ready:
Operating Agreement or Bylaws
The rules by which the company operates.
In a limited liability company, an operating agreement indicates the members, rules by which the company will be managed, capital contributions already made and to be made, and the distribution of profits. Some may include provisions preventing the sale of memberships to third parties or laying out procedures for resolving disputes between members. Putting these rules in place (or making time to update them) is vital if the company ever gets sued, a member dies, or members decide they can no longer work with one another.
Likewise, in a corporation, bylaws set out the company’s rules and regulations. They provide guidance on the officers the company will maintain, the duties of each, voting mechanisms for the board of directors, and the rights of shareholders. How decision-making is conducted, including who must be present to make decisions, is also addressed. These provisions are also important in a dispute, a sale of the company, or a major action such as acquiring another company or obtaining financing.
Records of Ownership and Transfers
Historically, keeping track of ownership and transfers of a company was done on a stock ledger. Many corporate entities still maintain one. With the advent of limited liability companies and the de-formalization of companies’ organizational structures, however, ownership records often slip through the cracks. In many privately held companies, it is clear who owns what. The issue can quickly get complicated when shareholders or owners pass away, get divorced, or when employee shareholders leave the company without giving up their shares. Transfers should be clearly documented through assignments and consent resolutions affirming the transactions that took place.
Records of Loans
The owners of a privately held company will often do anything to keep the company afloat during economic downturns, including loaning funds to the company. When this happens, it is important to document such transactions with promissory notes or other loan agreements. Having these documents is crucial when one owner, member, or shareholder makes a financial commitment and expects the company to repay them. Having all financial records evidencing loans and other transactions between the company and its owners keeps everyone on the same page — and makes it more likely financial obligations will be met.
Buy and Sell Agreements
In consultation with an attorney, every privately-held company should design and document a buy and sell agreement. Sometimes referred to as a shareholder restriction agreement, this document prevents shares from being sold outside the control of a privately held company.
It can also provide a mechanism to address the company’s future, what happens when a key employee leaves the company or retires, or if an unexpected departure, disability, or passing occurs. Buy and sell agreements also address the value of the owners’ interests in advance so that there is no dispute as to what the buyout price is at the time of departure.
Having a buy and sell agreement in place helps a business operate through uncertainty and continue for future generations.
When it comes to creating, updating, and accessing key documents, private company needs are not of the same complexity as those of a publicly-traded entity. However, the issues are no less important.
Zana Tomich is co-founding partner of Dalton & Tomich, PLC, based in Detroit, Michigan. The firm provides outside general counsel services to privately held companies.