Different types of legal entity documents
In a recent blog within these pages, we detailed the formation documents necessary for starting up various types of business entities. These documents, also known as registration documents, generally aid entrepreneurs as they begin to form and organize their individual business ventures. However, as a business develops beyond its initial phases, other important documents become necessary to keep it on track. These are the operational documents, which are used to control activity within the business as it proceeds.
Legal Entity Documents
As we begin to look at how these documents affect the operations of various business types, it is important to pause a moment on the ideas of ownership and control.
Depending on which type of business structure an entrepreneur chooses, these concepts will manifest themselves in different ways. The ownership and control of business typically begins with some sort of agreement between the owners or founders and the management.
Ownership agreements usually concern the following fundamentals:
- Control of the entity (or the authority to act on behalf of the entity in carrying out business activity). Which person or persons has the authority to make business decisions and enter into legal agreements on behalf of the company?
- Percentage of entity ownership. If the company is jointly owned by more than one owner, the agreement should define each owner’s total ownership share.
- Entitlement to profit and responsibility for losses. Who stands to make money if the business goes well, and, just as importantly, who bears the responsibility for any debts if the business does not grow?
Each type of business entity will have an inherently different relationship with regard to management, operations and ownership. Depending on which entity type you choose for your company, your answers to the questions above will vary.
Sole Proprietorship Entity Documents
A sole proprietorship is the most basic of business operations. Because a sole proprietorship has only one owner, issues of control or ownership operations are moot. In most states, there is no legal requirement to file any sort of documentation to start a sole proprietorship. One possible exception to this is the Certificate of Assumed Name. This certificate aligns the assumed name, or the name of the business, with the name of the business owner. Thus, it cements the bond between the two names, underscoring the fact that sole proprietors are personally responsible for any debt or litigation brought upon their company.
Beyond the Certificate of Assumed Name and any local or legal license requirements, a sole proprietorship requires no additional operational documents, though good practice would suggest that all ventures create a business plan to serve as a guide for planning operations.
Partnership Legal Entity Documents
Entering into a business partnership can be a challenging and rewarding experience. In the best partnerships, each member complements the other, creating a whole that is greater than the sum of its parts. In order for a partnership to operate at its best, experts advise that each partner collaborate on the crafting of a partnership agreement before the business gets off the ground. The partnership agreement (PA) should outline each partner’s control over the business, his or her ownership interest within the business, and each partner’s duties and responsibilities. In addition, the following are considerations to keep in mind when drafting a partnership agreement:
- Governance: What are the core values essential to running the business? What rules should guide the course of the business and what mechanisms can be created to make sure those rules are followed?
- Relationships: It is important to establish and define the business relationship that exists between the partners.
- Duties and Responsibilities: What actions will be expected of each partner? In what ways will each partner be held accountable?
- Profits: How will profits be distributed among the partners?
- Dispute Resolution: Establishing a mutually agreed-upon method of resolving possible problems before they arise can be vital for maintaining a healthy partnership.
- Dissolving the Partnership: What happens when one partner wants to leave the business? Included in this is the possibility of selling off a partnership.
If the partners do not create their own Partnership Agreement, then their operation is by default ruled by the standard partnership laws for their state.
Limited Liability Corporations (LLC) Entity Documents
In some states, Limited Liability Corporations (LLCs) are required to create an Operating Agreement. An Operating Agreement lays out the basic ideals governing the company and the expectations of its members. In particular, Operating Agreements define the following:
- Ownership: What is the ownership percentage and the profit and loss distribution among the LLC’s members?
- Authority: What are each member’s duties and obligations? How does the LLC define voting rights?
- Governance protocols: This establishes rules for meetings and voting.
- Decision-making: What are the rules for making business decisions?
- Leaving the LLC: How does a member extract himself from the company?
- Dispute Resolution: This establishes a mutually agreed-upon method of resolving issues between members.
As with the partnership agreement, many states have a default operations agreement that applies if the LLC does not create its own.
Corporation Entity Documents
There are two types of operational documents required of corporations, the Corporate Bylaws and the Shareholder’s Agreement.
The purpose of the Corporate Bylaws is to define the operating procedures within the corporation. Bylaws may cover a wide range of subjects, but at the very least, they should provide the following information:
- Name, address and principal place of business
- A list of directors and corporate officers
- Procedures for the election and appointment of officers
- Terms of service
- The amount of stock the corporation is authorized to issue
- Rules for director and shareholder meetings
- Standards for corporate record-keeping
- Procedures for amending the articles of incorporation and bylaws
A Shareholder’s Agreement is a document drawn up among shareholders to define the specifics of their ownership and rights. These documents are not necessarily publicly filed and the contents may vary from company to company. In general, Shareholder’s Agreements concern the following issues:
- Shareholder eligibility
- Procedure if shareholder leaves, dies or is fired
- Shareholders’ rights and obligations
- Valuation of stock for internal purposes
- Entitlement or obligation to repurchase stock
- Information on the regulation of the shareholder’s relationship
Facilitate document compliance with Diligent
Maintaining a thriving business is hard work. Crafting operational documents can help business owners plan and organize their business ventures so as to take full advantage of opportunities. At Diligent, we are happy to help growing businesses reach their full potential. For more information, contact a Diligent representative today.