When your business survives the startup phase, you are to be congratulated for beating the odds. If you’re regrouping to take your business to the next level, this may be an opportune time for a check-up and perhaps a tune-up.
Business success and growing pains
You’re innovating. You and your product are better than the competition. You have revenues and cash flow. That’s all good!
Now, to take and keep the lead in your industry, you must make your product even better. It’s time for version 2.0. And this time you want to patent the improvement. That takes money.
So you’re negotiating to bring in another investor. Or a key salesperson.
But there’s a catch. They want a stake in the business: ownership (if they invest) or a share of the profits (if they grow the business).
Your company agreement might need some work
One might think that most people have set up their businesses properly. Not so! Mistakes are common.
The good news is that the sooner issues are identified, the sooner they can be fixed.
A limited liability company (LLC) is often a good choice of business structure from startup through maturity. It’s fairly simple and flexible and it can provide for favorable tax treatment. Other structures can be considered, such as a sole proprietorship or an S or C corporation.
Let’s say you formed an LLC some time ago. Do you have a good operating (or “company”) agreement in place?
The operating agreement can and should set ground rules for ownership and management. It can provide for accounting and tax considerations. It can set the rules for how a member withdraws, e.g., whether, how, and to whom they can sell their shares. It can insulate LLC members from some financial liabilities. It also can provide the terms for how amendments are to be made.
Operating agreements are commonly amended. Just as businesses find it necessary to change direction, so should agreements be amended to keep up with the current reality and to provide for intended growth.
From a growth perspective, a good operating agreement can help make your business attractive to investors and key employees. And if amendment of the agreement will help you accomplish your goals, amendment should be considered.
Two common oversights in LLC setup
Among other issues in the setup of an LLC, these two are common:
- Picking the right company name and clearing and protecting it as a trademark; and
- Choosing the right form of management for the company.
We’ll address each of these issues in turn.
1. Selecting the right name/mark
When you started your business, one of your first choices was to pick a name for the company. You are not alone if you made a less-than-optimal choice of company name.
Most startups pick a name that isn’t distinctive. Or one that fails to suggest their line of business and their unique selling proposition. They think that just because the Secretary of State agreed to register the name, they must have cleared and protected it as a trade name or trademark. (That’s logical, but incorrect.) Most likely, the business has turned out to be something different from what you first planned, so the name needs tweaking anyway. Now it’s time to clear a mark properly, and to file for a federal trademark registration.
2. Choosing between member control and manager control
A key choice you made on starting up is who makes the decisions—who controls the day-to-day business of the company. A common choice is a member-managed LLC. That’s usually the default under the laws of most states. But that can lead to quarrels and paralysis.
A manager-managed LLC sometimes works better. It’s especially appropriate when one person puts in most of the capital and takes most of the responsibility for running the company.
These choices, along with others, should be documented in the operating agreement.
Put agreements in writing, get them signed, amend as needed
Some people try to make the operating agreement do too much of the work. Some of the details are better left to employment agreements, buy-sell agreements and the like. Covenants not to compete might be appropriate, depending on the situation and the state. Non-disclosure agreements (NDAs) and other provisions concerning intellectual property ownership and assignments can be critical to the health of the company.
Do your legal documents match the reality of what your business has become? Your documents should reflect how the company is actually owned and managed.
Does your LLC operating agreement provide the flexibility needed for your current and anticipated needs? If there is a gap, it might be appropriate to amend the documents to match the reality and the intended direction of the company.
In the absence of good, written, signed agreements, disputes between members can create a crisis, and the result might be determined by defaulting to your state’s laws. Such determinations can be imposed by a court. And that might not be pretty.
Why it matters
Well thought-out and carefully tailored legal documents can help your business to succeed and attract and keep investors and key employees. If your business has changed, or if you are planning to change, you might benefit from review and amendment of legal documents including your LLC operating agreement.
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