Once you have formed a legal entity, you are not done yet. You still need to prepare detailed organizational documents governing your business and its owners. Below is a list of some common types of entities and the appropriate corporate governance documents:
Limited Liability Company: LLC’s are governed by an Operating Agreement. Operating Agreements primarily address (i) the designation of a manager as well as which decisions require member approval; (ii) how profits and losses are allocated to the members; (iii) distributions to members; and (iv) restrictions on transfer of member’s interests as well as related drag along, tag along or other sale rights, redemption rights or put/call options. If you don’t use an Operating Agreement, the LLC and relationship of its members will be governed by the state’s LLC Act and common law. One of the primary advantages of an LLC is that most provisions of the state’s LLC Act can be overridden by an Operating Agreement. Even if you prepare an Operating Agreement, carefully review the state’s LLC Act to determine which provisions you want to override and which provisions the statute indicates cannot be overridden by an Operating Agreement.
Corporations: Corporations are governed by Articles of Organization (sometimes referred to as Certificates of Organization or Charters) (“Articles”) and Bylaws. Articles typically address: (i) the various classes and numbers of shares; (ii) rights and preferences associated with each class of shares, including voting rights, dividends and liquidation preferences; and (iii) restrictions on transfer of member’s interests as well as related drag along, tag along or other sale rights, redemption rights or put/call options. Bylaws typically address: (i) the frequency and process for calling meetings; (ii) election of directors; (iii) appointment of officers; and (iv) indemnification of officers and directors. Shareholders of corporations also routinely enter into additional contracts such as Shareholder Agreements or Voting Agreements whereby they agree to vote their shares to accomplish certain objectives associated with the election of directors, appointment of officers, sales of the corporation’s stock or assets, tax distributions or elections and a variety of other issues.
Partnerships: There are various types of partnerships including Limited Partnerships, Limited Liability Partnerships and General Partnerships. All forms are Partnerships are governed by Partnership Agreements. Partnership Agreements look very similar to LLC Operating Agreements, albeit with different terminology. For various reasons beyond the scope of this article, Partnerships have largely been replaced by LLC’s as the preferred entity type for business owners looking to avoid the corporate formalities associated with Corporations.