What is an Owners’ Agreement & Why You Need One

April 13, 2021by Brian Walsh

An owners’ agreement is essentially a contract between the owners of a business, governing their relationship concerning that business. The goal of an owners’ agreement is to layout a structure of suitable rules to help owners overcome conflicting and unanticipated situations.

These agreements are often confused with corporate bylaws and LLC operating agreements. While bylaws and operating agreements may cover some of the same topics, they are primarily for internal management of the business. Whereas owners’ agreements are specifically focused on the relationship between the business’s owners.

Moreover, don’t lump owners’ agreements in with buy/sell agreements. Even though these two agreements have some areas of overlap they have wholly different focuses.

A buy/sell agreement is a legally binding document that outlines how one owner’s share of a business will be reassigned if they exit the business or are somehow incapacitated. An owners’ agreement, however, takes things a step further by also describing how the relationship between owners will be managed; both during and after they’re involved with the business.

By helping maintain a positive relationship between its owners, a well-crafted owners’ agreement can help the business succeed and grow over the long run.

The WhyWhy You Need An
Owners’ Agreement?

There are a number of reasons why your business should have a carefully drafted owners’ agreement in place.

1. Preserve The Business.

It’s perfectly natural to assume the best in people. And while a positive outlook is certainly admirable, it’s important to be a bit more cautious in business.

To this end, an owners’ agreement will help all the partners protect the business. This vital contract will detail what will happen if a business partner runs into a personal debt, gets into legal trouble, is getting divorced or the target of a lawsuit and their ownership interest is put into jeopardy.

If specific rules are not laid out, the business could end up with an unwanted or even hostile person as part of the ownership group.

An owners’ agreement will allow all the owners to plan for these issues and more—essentially ensuring the company has all its bases covered.

2. Resolve Potential Deadlocks

How do you and your business partners get along? While it’s great that you have a positive relationship, even the most practical people can disagree from time to time.

In business, disagreements can hurt the company—particularly when they turn into decision deadlock. Smaller business may find themselves crippled by decision deadlock, and forced to shutter.

Don’t let this be you. A comprehensive owners’ agreement will present solutions and action steps for future deadlocks, safeguarding the company as a result.

3. Make sure all owners remain vested in the business.

You don’t want to be stuck with a partner that is no longer participating in the business, as agreed. By the same token you don’t want to be stuck with a partner that has become toxic and are affecting the success of the business.

What if a key-employee was provided a percent of ownership at the outset of the business but then quits or is fired? Chances are you won’t want this person to maintain their interest in the company.

But without an owners’ agreement in place, you might not have a choice.

4. Don’t get strangled by default state rules.

Though the specifics tend to vary, all U.S. states have specific rules pertaining to how businesses can operate.

They’re simply the minimal set of rules and regulations set by the state where the business is located. So, they aren’t always sufficient. Again, this is where an owners’ agreement comes in.

These documents are customizable, meaning that you can make sure you don’t simply fall into the state’s default rules if something goes wrong.

Consequently, it’s important that businesses develop a comprehensive owners’ agreement from the very beginning. And since companies tend to grow and evolve over time, you’ll want to revisit and revise it periodically — ideally, every few years.

By doing so, the owners can make sure the agreement is clear, modern, and that it makes sense for their current business needs.

The WhatWhat Is Included In
An Owners’ Agreement?

These agreements can easily be tailored to reflect the expectations of the ownership group. However, the following items are key components of a well thought out owners’ agreement:

1. What Are The Owners’ Rights And Responsibilities?.

Will all owners have the same rights and responsibilities? If those rights and responsibilities are different. Is the difference based on; for example, investment amount, role, or date of buy in.

Can an owner own another business, sit on board or act as an advisor that competes with the initial business?

How will new investors be added to the business, and in what capacity? What steps need to be taken in the event of retirement, death, or incapacity of an owner?

If you do not outline these types of issues ahead of time, it will become difficult to resolve them in the future.

2. Who Will Manage The Business And Make Decisions?

The owners’ agreement should outline who will handle the daily operations and who can make what type of decision. Will business operations be controlled by the ownership group or will managers be hired. Who can make significant decisions like dissolving the business or selling business assets?

No matter what management and decision making structure is implemented everyone must be clear on who has the authority to make management decisions (and on whether decisions should be made unilaterally or by majority or unanimous vote).

These are significant issues that need to be addressed. You wouldn’t want to visit the business one day and find out a manager or owner had made the unilateral decision to sell off a crucial piece of equipment or made a strategic decision without consulting the other owners.

3. Dispute Resolution

The goal, of course, is to avoid major disagreements—but you should still prepare for what might happen in the event of a dispute. It is inevitable. There will be disputes. How will those disputes be resolved?

Having a predetermined way to resolve a dispute could keep the situation from spinning out of control. Nobody wants to go to court. It engenders bad feelings and could damage long standing relationships.

Besides, taking things to court can be costly and is almost always part of the public record and will ultimately only serve to distract from actually operating the business.

4. Investment And Contributions

It’s no secret that businesses need money to operate. A new business, in most cases, will depend on the resources of its shareholders in the beginning stages.

All the specifics should be available in writing. This includes how the business will obtain initial funding, and whether the owners will be asked to make additional contributions moving forward.

If the business seeks loans or other external investments, the owners’ agreement should outline these sources’ terms and conditions.

5. Compensation

Once the business is profitable, the partners can start to withdraw money from the company. The owners’ agreement will cover when the owners can take money from the business, how much money they can take, and how they can go about taking it.

This means describing in detail how the owners will share the business profits, including whether some partners have priority over the others. It’s also important to determine whether the amounts will be paid as distributions, dividends, or salaries.

5. Restructuring, Modification, And Transfer Restrictions

It’s perfectly natural that the business will expand or evolve over time. The owners’ agreement will describe the process for making and adapting to change.

This clause will reveal whether partners are allowed to transfer their ownership in the business, and to whom. It will outline any limitations or restrictions on the transferability of ownership, along with a process for making modifications to the business or its governing contracts – including the owners’ agreement.

7. Sale, Exit, Or Dissolution

Every business needs an exit strategy. To this end, the owners’ agreement should describe what should happen if an owner wants to exit the business or if the business is sold or merged. If one owner plans to sell their share, or if two partners plan to exit in a year while a single person remains, these details should be documented.

It’s also important to address potential scenarios like dissolving the business. No matter the circumstances, the owners’ agreement should describe all the steps owners can take to end their arrangement, along with any limitations or requirements.

We Can Help YouDraft or Revise Your
Owners’ Agreement Today

Governing documents like owner’s agreements are complex documents. They should be in writing and consistent with all other governing documents. Having conflicting clauses is a sure way to wind up in a dispute and possibly end up in court, if any issues were ever to arise. Work with the experienced business attorneys at Walsh Banks Law to make sure your business as-well-as your rights and privileges as an owner are protected.

If you need help drafting / revising an owners’ agreement in Florida or just have a question, connect with Walsh Banks Law today.

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