Business people with great ideas want to move on them quickly and see them flourish in the marketplace. Even new businesses often keep their eyes on an aspirational prize: the “exit strategy”. However, many businesses encounter difficulties and sometimes even debilitating conflicts during their life cycle because not enough attention was paid to the company’s organizational structure, or what could be called the company’s “entrance strategy.”
Choice of Entity
Corporations and limited liability companies provide limited liability protection for their managers and owners. However, the tax treatment (and the resulting implications for owners) can vary significantly, so it is important to consult with a tax adviser when selecting the form of entity that makes the most sense for each individual’s tax situation and the company’s business plan. Limited liability companies offer flexibility in terms of customizing the organization and its management, while corporations provide more well-established structural provisions. That is, corporate statutes provide more “gap-fillers” in the event business owners fail to provide for certain contingencies and procedures in their organizational documents.
One of the most fundamental, and yet most often hurried, neglected or even ignored, parts of starting a business is crafting the organizational documents for the company. Subject to requirements imposed under applicable law, these essential documents serve as the ground rules for the business and provide a framework for making decisions down the road.
For corporations, the organizational documents include articles of incorporation and bylaws, and sometimes separate stockholder agreements. LLC organizational documents include articles of incorporation and typically an operating agreement. In the absence of a written operating agreement, members and managers often find themselves without a mutual understanding of management structure and decision-making authority, and in the event of a dispute they quickly confront the difficulties of interpreting and enforcing an oral contract.
Nevada law allows businesses a meaningful level of flexibility in customizing these organizational ground rules in order to give owners and managers control over how they will interact. Some examples of potential questions and issues to address include those identified below:
Finance and Capital: How much capital will each owner be required to contribute at the outset (and in exchange for what percentage ownership)? Who will decide if/when the company requires additional capital and what amount, if any, is required from each existing owner? How will the company’s budget be determined and who can authorize deviations from the budget? Will there be restrictions on the company’s ability to incur debt or pledge its assets as security for loans? How will decisions regarding new investors be made?
Management: Who will have authority with regard to day-to-day operations? Will any major decisions be reserved to certain individuals or be subject to special approval requirements? How will deadlock situations be resolved?
Ownership Transfers: Will there be any restrictions, conditions or approval requirements regarding transfers of ownership?
Special Considerations: Will the company be engaging in a regulated industry, like gaming, such that the governing documents need to include certain provisions? Will the owners or managers be limited in their other activities, including those that may compete with the company? Will the other owners be entitled to buy-out another owner in the event of bankruptcy, divorce, death, finding of unsuitability or other major events?
Addressing these issues and questions at the outset should not be viewed as an attempt to solve every potential problem in advance. Entrepreneurs could easily paralyze themselves trying to anticipate every contingency and possible disagreement. Instead, a company’s organizational documents should address basic issues and concerns, while providing a clear and solid framework for resolving disputes and making tough decisions. Documenting a clear understanding of the mechanisms by which the company’s internal affairs will be governed, and by which decisions will be made, will allow managers and owners to be more efficient in conducting the business and potentially avoid disputes that would otherwise disrupt the company’s operations.
Albert Z. Kovacs, shareholder, Brownstein Hyatt Farber Schreck