DIY Corporate Law: Great expectations turn into unexpected consequences

By Melissa G. Cassell

Many of us are reared to save money by rolling up our sleeves and putting in sweat equity, but sometimes we really should call a professional. Just as we would not tackle a bathroom addition in our home without professional help, a business owner or entrepreneur should not tackle the formation and organization of his business without legal counsel.

One of the first steps when starting a business should be forming the proper entity to operate the business. Consider a company with a sole owner and a joint business enterprise. The decisions of the sole-owner company are made by the sole owner – and the sole owner reaps all the rewards or suffers all the consequences. In the joint business enterprise – whether operating as a partnership, a corporation or a limited liability company – all company decisions must be made jointly. By using one of the many do-it-yourself (DIY) legal websites to form your business entity, you lose the ability to match company decision-making to co-owners’ expectations and to properly protect co-owners’ interests.

Depending on the entity type you form, you will need an operating agreement (for a limited liability company), bylaws or a shareholder management agreement (for a corporation), or a partnership agreement (for any type of partnership) to serve as the governing document of the company. This governing document is the heart and soul of the company, as it declares, among other key terms, who owns what, how decisions are to be made, how profits are to be distributed and who has authority to act within the company. Anytime there is potential for litigation, whether among the owners or with a client or lender, the governing document will be one of the first items all parties turn to.

When a governing document is created using a DIY corporate law service, it rarely matches the owners’ intentions. For instance, a governing document that requires a majority vote to make decisions in a company with two owners having equal ownership is almost certain to result in a deadlocked company.

The importance of buy/sell agreements

In addition to, or as a part of, the governing document, every company with multiple owners should have a buy/sell agreement. Owners may see the business through rose-colored glasses today, but you should always be prepared for what tomorrow could have in store. Whether it is a bad economy, personal finance troubles, disability due to an accident or death, owners do not want the company to be subjected to a bad turn of events without a strategic plan in place.

A buy/sell agreement is a mechanism for owners of a company to agree in advance as to how a break-up will be handled and to provide a funding mechanism for the company to survive the break-up. Often, key person life insurance is used for funding upon the death of an owner, but an array of other funding methods are also common.

When owners of a company fail to adopt a buy/sell agreement, they will find themselves subject to default statutory rules for a buyout of ownership. Envision: a co-owner of a company dies unexpectedly while travelling overseas. If the company has no buy/sell agreement in place, chances are the deceased owner’s spouse or children now own his interest in the company, and chances are even better that the remaining co-owners absolutely do not want to be in business with the spouse or children (or heaven forbid, both). However, under default statutory rules, this may be the case, unless and until the company and the spouse and/or children are able to agree to a fair market value for deceased co-owner’s interest in the company. This is probably not what any of the parties expected, intended or would have chosen as a course.

Whether you are starting a new business or you have been doing business for years, it is crucial to have a current and accurate governing document and buy/sell agreement in place that matches everyone’s expectations and that everyone understands. Do not wait for a dispute to arise or bad fortune to hit. Find a corporate attorney and get everyone to the table now. Once a dispute among co-owners reaches the surface or bad fortune takes its course, it is often too late to create a sensible exit strategy and dispute resolution plan, and years of time-consuming and expensive litigation may be on the horizon.

Melissa G. Cassell is an attorney with Morton & Gettys LLC in Rock Hill, South Carolina. Her practice includes employment, health care and business and corporate law. You can reach her at 803.366.3388 or at Melissa.cassell@mortongettys.com.

Information or interaction on this page should not be construed as establishing a client-attorney relationship or as legal advice. For advice about your specific situation, please consult one of our attorneys.

Melissa Cassell

Associate

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