Litigators are fairly well known to be the scourge of the civilized world. After all, they are responsible for the number of lawsuits as well as the enormous costs associated with them, right? The truth is that I know litigators like that, but the majority of business attorneys I know do their best to keep their business clients from getting into legal battles. Saving the client from their own mistakes is sometimes difficult. It is made exponentially more difficult when the business owner decides it is cheaper to form the business using one of the various online services or legal software. They might as well be stamped with a warning that in case of a dispute, they almost guarantee full employment for litigators.
Aren’t Online Formations Fast and Cheap?
Yes, they are easy, fast, and cheap. After spending a few moments on the computer and a few dollars on the credit card, your business is up and running and legal in your state, so what can go wrong? Well, if recent history is any indicator, the answer to that is: plenty. As I have said before, few people go into business with a friend or family member thinking that they will one day have a disagreement regarding how to run the business. Many internal business disputes between owners could be avoided with proper documentation. Still, although most disagreements don’t end up being settled in the court system, the cost if your dispute does go to court is astronomical compared to the cost of prophylactic measures.
That is where the online services are weak. They get you up, running, and legal, and you will have your articles of incorporation or your other organizational documents. But they do not do a good job of setting out the relationship between owners and who has operational control, etc. And that is a problem when things don’t go perfectly. As a business owner, when have things gone perfectly for you? That’s what I thought. So why would you think you will always agree with your friend or relative on how to run the company. If you are human, you will not always agree.
How Can an Online Business Formation Ruin Your Company?
So, what is the remedy? A well crafted shareholder agreement, partnership agreement, or operating agreement (depending on the entity choice). At a minimum, it should set out the desires of the owners regarding the following:
- Management of the day-to-day operations
- Decision making regarding out-of-the-ordinary decisions
- Hiring and Firing authority
- Authority to borrow or spend money
- Method for sharing profits and losses
- Under what circumstances one’s interest may be sold
- Under what circumstances the current owners may offer an interest in the company to a new owner
- What happens to one’s ownership interest if an owner dies
- What happens to one’s ownership interest if an owner becomes disabled
- What happens to one’s ownership interest if an owner gets divorced
- Management succession in case an owner becomes disabled or dies
- Duties and obligations of each owner in order to qualify for a share in the profits
- Whether the day-to-day operator/manager is to be paid a salary in addition to a division of the profits
- Method for resolving disagreements between the owners regarding extraordinary decisions (admitting new owners, taking on debt, etc.)
- A Buy-Sell agreement provision for divorce, death, disability, bankruptcy, etc.
Why should these things be covered? Because they are often the source of disagreements between business owners if the business does not have an agreement covering these topics (which I have yet to see from any online business formation service or software). So, what happens when there is no agreement? Both sides hire attorneys who argue about what the parties may or may not have said to each other in days gone by, or they argue what the law should be in light of the parties’ silence on the matter. That means money to attorneys.
What is the moral of the story? Unless you can be certain that you will never have a dispute with your other business owners, you should have a management agreement. Since online formation companies and legal software door a poor job at this task, you are playing Russian Roulette if you think they are saving you money. In the majority of cases, your dispute will not end up in court, but the one time it does may just kill your business.