The business you own today may look very different from the business you started.
Maybe you began by yourself and now have employees. Perhaps you brought in another owner, expanded into a new location, added a new line of business, took on substantial debt, or built something that is worth considerably more than it was a few years ago.
Your personal life may have changed too. You may have gotten married or divorced, created or updated your estate plan, had children, or changed the people you would trust to step in if something happened to you.
But when was the last time anyone looked at the legal documents governing the business?
For many California business owners, the operating agreement, bylaws, shareholder agreement, partnership agreement, or buy-sell provisions were created when the business was formed and have barely been touched since.
That can become a problem because the legal structure of your business should reflect the business you actually own today, not the company you expected to build five or ten years ago.
Your Business Documents Do More Than Establish the Company
Formation documents are only the beginning.
For an LLC, the operating agreement can address the relationships among the members, management of the company, voting rights, distributions, transfers of ownership, and what happens when certain events occur.
A corporation has a different structure. Its articles, bylaws, shareholder agreements, stock records, board resolutions, and other corporate documents can determine who has authority and how decisions are made.
A partnership may rely heavily on its partnership agreement.
Then there may be a buy-sell agreement governing what happens if an owner dies, becomes disabled, retires, wants to sell, or experiences another triggering event.
These documents do not all serve the same purpose, and having one does not necessarily solve a problem that should have been addressed in another.
That is why I do not simply ask a business owner, “Do you have an operating agreement?” I want to know whether the company’s documents actually work together and whether they still reflect the owner’s intentions.
Growth Is Often What Makes an Old Agreement Stop Working
A basic agreement may have been perfectly adequate when you started the company.
Then the business grew.
Imagine two people formed an LLC several years ago and each owned 50 percent. At the time, they handled nearly everything together. There was little revenue, few assets, and no reason to spend much time thinking about what might happen if they disagreed.
Years later, the business has employees, valuable contracts, significant cash flow, and two owners with very different responsibilities.
Now a 50-50 vote can create a deadlock.
Or perhaps one owner invested considerably more money than the other. Maybe one works full time in the business while the other has stepped back. One owner may want to sell while the other wants to keep growing.
The operating agreement they signed at formation may technically still be their agreement, but it may no longer address the business relationship they actually have.
The same thing happens in corporations. The bylaws may reflect officers who are no longer involved. Corporate records may not reflect changes in how decisions are actually being made. Stock-transfer restrictions or shareholder agreements may no longer accomplish what the owners intended.
Business growth is usually something to celebrate. It is also a reason to make sure the legal structure grew with it.
Adding or Losing an Owner Should Trigger a Legal Review
Changes in ownership are one of the clearest times to revisit the company’s documents.
Bringing in another owner affects much more than someone’s percentage of the company. You need to consider voting rights, management authority, capital contributions, distributions, compensation, access to information, restrictions on transfers, and what happens if the relationship does not work out.
Owners also need to think about how someone leaves.
Can an owner simply sell an interest to anyone? Do the other owners have the first opportunity to purchase it? How will the business be valued? Is there a required buyout when someone retires? What happens if an owner is terminated from employment but still owns part of the company?
Those questions are much easier to answer while everyone is getting along.
A vague agreement can become very expensive once the owners disagree because the parties are no longer negotiating about a hypothetical future event. They are negotiating while each person has money, control, and sometimes a livelihood at stake.
Death and Incapacity Need to Be Addressed Before They Happen
This is where business planning and estate planning often collide.
A business owner may have a carefully prepared revocable living trust and assume that transferring the business interest to the trust completes the planning.
It may not.
The estate plan tells us who should receive or manage the owner’s property. The company’s governing documents may separately determine what rights come with that ownership interest and whether a transfer is permitted.
For an LLC, California law specifically recognizes that death and certain incapacity events can affect a person’s status as a member, and the operating agreement can play an important role in determining what happens next.
Corporations can present different issues. Shares may be subject to transfer restrictions, shareholder agreements, or buy-sell provisions. California law expressly recognizes that corporate shares may be subject to restrictions on transfer.
This is why I want to review the estate plan and the business documents together.
If your trust says your children inherit the business but your buy-sell agreement requires your interest to be sold to the remaining owner at death, those documents are trying to accomplish different things.
If your spouse will inherit the economic value of the company but you do not want your spouse running the business, that distinction needs to be addressed.
If a successor trustee will step in during incapacity, we need to understand what authority that trustee will actually have with respect to the company.
There is no universal answer because the right structure depends on the business, the ownership arrangement, the governing documents, and what you want to happen.
Your Buy-Sell Agreement May Need Attention Too
I often find that business owners know they signed a buy-sell agreement but have not looked at it for years.
That agreement may be one of the most important documents in the company.
A well-designed buy-sell arrangement can address what happens when an owner dies, becomes disabled, retires, voluntarily leaves, is terminated, files bankruptcy, divorces, or wants to transfer an ownership interest.
But even a good agreement can become outdated.
Perhaps the valuation formula was created when the company was worth $500,000 and the business is now worth several million dollars. Maybe the agreement requires life insurance to fund a purchase at death, but no one has checked whether the insurance is still adequate.
The owners may have changed. The company’s debt may have changed. The intended successor may have changed.
And sometimes the agreement contains a valuation method that no one would choose today if they were starting fresh.
The fact that you have a buy-sell agreement is helpful. The more important question is whether it would still produce the result you want.
Your Corporate Records Should Match What Is Actually Happening
Another issue I see is a disconnect between the formal records of the company and the way the owners have been operating it.
Maybe someone has effectively been serving as an officer for years, but the corporate records were never updated. An LLC may have changed managers without properly documenting the change. Ownership percentages may have changed informally without the records being brought up to date.
Business owners are understandably focused on running the business. Corporate minutes, resolutions, ownership records, and amendments are easy to push aside when clients, employees, and revenue require immediate attention.
But those records become much more important when the business is sold, an owner dies, a dispute develops, a lender conducts due diligence, or someone needs to establish who actually had authority to act.
California does not require an LLC’s operating agreement or a corporation’s bylaws to be filed with the Secretary of State. They are internal company documents, which is another reason they can sit untouched for years while the business changes around them.
Certain Changes Should Prompt a Review
You do not need to rewrite your legal documents every time something changes in the business.
There are, however, events that should cause you to pull them out and take another look. Those include adding or removing an owner, a significant increase in the value of the company, a marriage or divorce, changes in management, taking on substantial debt, purchasing significant assets or real estate, changing the way owners are compensated, bringing family members into the business, updating your estate plan, or beginning to think seriously about retirement or succession.
A periodic review also makes sense even when there has not been one major event. Businesses have a way of changing gradually. Five small changes over several years can leave you with documents that no longer describe the company very well at all.
Your Business Plan and Estate Plan Should Tell the Same Story
I work with clients on both sides of this equation, which is why I pay particular attention to how business documents coordinate with estate planning.
Your trust, Will, and powers of attorney should not exist in one world while your operating agreement, corporate documents, and buy-sell agreement exist in another.
If something happens to you, all of those documents may suddenly have to work at the same time.
Who owns the business? Who controls it? Who receives the economic benefit from it? Can an ownership interest be transferred? Does another owner have a right or obligation to purchase it? How is the value determined? What happens while you are incapacitated rather than deceased?
Those questions should have coordinated answers.
For many business owners, the business is one of their largest assets. It may also represent decades of work, a source of income for the family, jobs for employees, and a significant part of what they eventually hope to leave behind.
That deserves more than documents that have not been reviewed since the company was formed.
If you own a California business and it has been several years since anyone reviewed your operating agreement, bylaws, shareholder agreement, buy-sell agreement, or other governing documents, this may be a good time to take another look.
At Cheever Law, I help business owners review the legal structure of the company alongside their personal estate and succession planning so that the pieces work together. If your business has changed since your documents were created, contact us or schedule a 15-minute introductory call to talk about whether your planning still fits the business you own today.