In Part 2 of this series, we discussed the differences between the most common entity types: sole proprietorship, general partnership, limited liability company, and corporation. In Part 3, we covered the benefits of electing s-corp tax status as a LLC or corporation.
In this post, we will cover the considerations for forming corporations or LLCs with multiple owners. Of course, the biggest difference is whether you have to deal with other humans.
When you are a single member LLC owner, you will have an operating agreement or bylaws. That document exists primarily to help demonstrate that you are following corporate formalities such that you don’t end up having your personal liability disregarded (yikes – more on that in a future post). The operating agreement in a single member LLC can change at the whims of the 100% owner. You are the undisputed king in this scenario. So, the rules of the company are whatever you say they are, your majesty.
On the other hand, when there are business partners in the mix, matters get much more complicated. The partners must reach an agreement among themselves regarding how the affairs of the company will be decided.
7 Common Multi-Owner Operating Agreement Issues
The issues that are most addressed in operating agreements and bylaws for small businesses are addressed below.
· Equity Percentages. What percentage of ownership in the company does each owner have? Is this ownership equity based on cash payments or is it based on sweat equity? Sweat equity agreements must determine when the equity vests and under what circumstances.
· Officers and Salaries. I have found that it is a best practice to have language in the operating agreement regarding who the officers running day to day operations will be and on what basis they will be paid.
· Voting. How will decisions about the company be made? What types of decisions can be made by officers/employees of the company and what types of decisions must be approved by the members or shareholders? Voting is typically based on ownership percentage. However, there can be different thresholds required for different decisions. For example, a 70% vote can be required for some issues and a simple majority for others.
· Capital Contributions. Are owners required to put additional contributions into the company? What percentage of vote is required? What happens if an owner fails to contribute when required?
· Distributions. When will profits be distributed? What is the process for deciding how much money should be distributed?
· Member Withdrawal/Death/Termination. What happens if a member withdraws from the company (whether voluntary or by death) or is terminated by other members? Can a member even be terminated? If so, how, and for what reasons? What does a withdrawing or terminated member get paid for their ownership and on what terms?
· Non-Competes. Is there any reason to have a non-compete agreement such that the other partners are not working on any similar projects and are dedicated to the common venture?