9 Internal Agreements Business Owners Need
Operating Agreement (LLC)
This is the contract that governs the internal operations of an LLC. Unlike the LLC’s Articles of Organization, which contains only the most basic information about your business and has to be filed with the state, the Operating Agreement is the detailed contract between the members of the LLC detailing how the business will operate. It should address matters such as your business’s equity structure (capital accounts, member contributions, and allocation of profits, losses and distributions); management; voting; buyouts and other transfers of management interest; confidentiality and non-compete provisions; indemnification and limitation on liability; governing law; and dispute resolution.
This is the contract that governs the operations of a partnership. The specific provisions will be different for each business, but generally, a partnership agreement should state the contributions of each partner; the rules for admitting new partners; how profits and losses are to be distributed; whether the partnership is to retain any profits for business needs; management; voting; keeping of records, books and financial statements; power to borrow money; authority to incur liability on behalf of the business; buyouts and other transfers of interest; confidentiality and non-compete provisions; indemnification and limitation on liability; governing law; and dispute resolution.
Joint Venture Agreement
Similar to a partnership agreement, a joint venture agreement is a contract between members of a joint venture, defining the operations, scope and objectives of the collaboration. Any time you collaborate with someone on a new project or event, whether it’s a multi-million dollar business venture or a guest-blogging gig, you should prepare and sign a Joint Venture Agreement. The Joint Venture Agreement should set forth clearly the contributions expected of each member; the management structure of the venture; debts and financing considerations; how disputes will be handled; ownership and licensing of IP and technology; consequences of any breach or default by a member; non-compete and non-solicitation provisions; share transfers; exit and termination rights; termination and dissolution; among other considerations.
The bylaws of a corporation outline the structure of the organization and detail how the company will operate. Unlike the Articles of Incorporation, which contain only the most basic information about your company and must be filed with the Secretary of State, Bylaws contain the company’s internal rules and do not have to be filed. Nevertheless, you do need them, especially if you’re in a state that doesn’t consider your company formed until its board of directors has adopted bylaws. Typical issues addressed in corporate bylaws include: a statement of your company’s purpose; number and classes of shares; issuance and transfer of stock; voting rights; election and qualification of the board of directors and any committees; election, appointment and responsibilities of officers; board meetings and minutes; shareholder meetings; limitation of liability and indemnification provisions; conflict of interest disclosures; confidentiality and non-compete provisions; governing law; dispute resolution; and formal procedures for amending the bylaws.
Shareholders’ Agreement (Corporations)
Shareholders of a corporation – usually its founding members – often enter into shareholder’s agreements to address aspects of their relationship that aren’t covered in the corporation’s bylaws. For example, shareholder agreements typically lay down the rules for the sale and transfer of equity shares, as bylaws typically don’t address what shareholders can and can’t do with their equity. In addition to clarifying the rights and obligations of the shareholders among each other, shareholder agreements may also include some obligations of the corporation to the shareholders that are not covered anywhere else. Some common clauses found in shareholder agreements are: buy-sell provisions governing the purchase of stock owned by a shareholder who can no longer participate in the business due to death, disability, divorce or bankruptcy; rules that require shareholders to actively participate as board members or officers; voting agreements; restrictions on the voluntary transfer of stock, such as a right of first refusal provision for the benefit of existing shareholders; tag-along rights allowing minority shareholders to sell their equity if majority ownership of the corporation is ever transferred; capital call provisions explaining what happens if additional capital needs to be contributed by shareholders for operational needs; a buy-out clause; dispute resolution procedures; non-competition provisions; limitations on the authority of the Board of Directors, etc. A shareholder agreement should address how conflicts between its provisions and the corporation’s bylaws are to be handled. Typically, in cases of conflict the shareholder’s agreement controls, because it’s specifically drafted to govern the shareholders’ relationship. Once a conflict is discovered, the bylaws should be amended to eliminate the conflict.
As the name suggests, this is an agreement between co- founders of a business establishing some important rules around decision-making, operations and ownership, and serves as a baseline for further co-founder negotiations as the business grows and inevitably changes over time. Because of this, the founder’s agreement is typically not binding. Nevertheless, it is an important document in which co-founders set out their expectations and define how their relationships will work, in order to avoid unnecessary surprises and confrontations later on that may jeopardize the future of the business. You can use the founder’s agreement to define your goals, values, philosophy and company culture; determine the responsibilities of your corporate officers (President, CEO, CFO, COO, CTO, etc.); include a vesting schedule when issuing initial shares; include important IP protection and assignment provisions; and define how equity will be split among co-founders.
Stock Purchase Agreement (Corporations)
This is the contract that people sign when shares of a company are being bought and sold. It contains all the terms and conditions related to the transaction, including the purchase price and any adjustments; representations and warranties made by the buyer and seller; employee matters, including post-transaction bonuses and benefits; dispute resolution provisions; tax issues; indemnification provisions regarding undisclosed or unforeseen post-transaction costs.
Convertible Notes and SAFEs
A popular way for startups to raise seed financing, convertible notes are issued by a company to investors in exchange for their investment in the business. The notes represent a short-term debt that converts into equity in the company, in the form of preferred stock issued to the investor at the closing of an initial round of financing. Look at it as the investor loaning money to a startup, but rather than get their money back with interest, they receive shares of preferred stock. Some of the key provisions of convertible notes are: discount rate provisions relative to investors in subsequent financing rounds; valuation cap; interest rate; and the note’s maturity date. A SAFE (Simple Agreement for Future Equity) is a new financial instrument, which has become popular with early stage companies (probably because it was invented by startup incubator Y-Combinator). Unlike a convertible note, a SAFE is a convertible security that is not debt, but a warrant to purchase stock in a future equity round. SAFES therefore don’t include an interest rate, and don’t necessarily have a maturity date. They are believed to be shorter and simpler than convertible notes, although this is the subject of some ongoing debate.
If you co-own your business, you want to think about what will happen to the company if one of your partners becomes disabled, dies, gets divorced, or retires. If you don’t want to be stuck having to share your company with heirs and ex-spouses of former members (who may or may not care about your business as much as you do), you should consider executing a buy-sell agreement. Also referred to as a “business prenup,” a buy-sell agreement is a contract between co-owners that defines what will happen to the business if one of the owners leaves. It sets out what will happen in the event of death, disability, retirement, divorce, sale of the company, or bankruptcy. The contract defines how the owners can sell their interests in the business, when they can sell, who they can sell to, and how much they can sell for. A typical buy-sell agreement requires an owner (or their estate) to sell their interest back to the company, and requires the remaining owners to buy it back from said owner or estate, at a fair price set in advance. It’s a good way to avoid disagreements between an owner who wishes to retire and those who wish to remain, not to mention the complex financial and tax problems created by an owner passing away, retiring, or otherwise leaving the business. Whether your business is a corporation, partnership, LLC or sole proprietorships, it’s always a smart idea to draw up a buy-sell agreement when the business is formed.
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