Every business needs a set of governing legal documents. For a corporation, these include a certificate of incorporation, bylaws and often a shareholders’ agreement. For a limited partnership or limited liability company, they include a formation certificate and either a partnership agreement or operating agreement. The purpose of these documents is to establish rules governing how the business will be managed and the rights and obligations of the owners.
Entrepreneurs and small business owners often pay little attention to these documents when starting a new business. They view them as paperwork, as necessary boxes to check but unimportant to the long-term success of the enterprise. It is important to understand that governing documents have important practical consequences, so they devote little time and few resources to them, frequently using “off the shelf” forms from cheap legal document services or attorneys with little or no experience in corporate governance matters.
Here are three common scenarios in which governing documents play a crucial role:
- Dealing With New Investors. Potential investors in a business will scrutinize governing documents to understand their rights and obligations should they decide to invest and to determine whether the business has been run in compliance with the documents and applicable law. This is especially true of sophisticated investors such as venture capital and private equity firms, and even “angel” investors. If the documents are considered insufficient and need to be redrafted, this can add substantial expense and delay the closing of a potential equity investment.
- Negotiating a Merger or Sale. A prospective buyer or merger partner will perform the same type of due diligence as would a potential investor. Unclear documents will delay closing and complicate the delivery of legal opinions that may be required in M&A transactions. Moreover, governing documents determine how a merger or sale must be voted on by the owners and if those documents are silent on the issue, then statutory rules will govern and those rules may impose unintended consequences.
- Conflicts Among Owners. Most owners of new businesses assume that relations with their co-owners will remain harmonious. Often that proves to be the case, but when it does not, governing documents are critical in resolving the dispute. They define the rights and obligations of the owners on such matters as voting, representation on the board of directors, access to company books and records and the distribution of assets. Well-drafted governing documents can keep the dispute out of court or, if it does end up in litigation, make a resolution faster and less costly.
Well-drafted documents, tailored to the specific needs of a business, need not be expensive. Attorneys experienced in corporate governance matters can prepare them efficiently. It is a sensible investment that will pay off in orderly management and future cost savings.
If you are starting a business and need new governing documents, or if you want your existing documents reviewed and updated, the experienced professionals at Capobianco Law Offices can help.