Wednesday, October 19, 2011

Ten Legal Mistakes Made By Start-Ups: I Don't Need an Operating Agreement/Shareholder Agreement

Continuing with the theme of the my October 17 post regarding ten legal mistakes made by start-ups, here is mistake number 2:

Myth #2:  I Don't Need an Operating Agreement/Shareholder Agreement or I can just get one online.

If you have a partner in your business, even if it is your best friend since you were in kindergarten, it is a mistake to believe you do not need an Operating Agreement (for an LLC) or Shareholder Agreement/By Laws (for a Corporation). 

First, under New York law, an LLC is required to have an Operating Agreement.  In the absence of an Operating Agreement, the parties are bound by the default terms of the New York Limited Liability Company Law.  Among the default provisions, the LLC will be deemed to be member-managed, meaning any partner has a right to bind the LLC -- this can be a signficiant problem if you believe you were the only partner who was to have management rights.

Second, the Operating Agreement or Shareholder Agreement will delineate the rights of the members/shareholders thereby (hopefully) avoiding disputes.

Third, I have found that when a partner can point to a provision of an Operating Agreement/Shareholder Agreement the parties can rely on the written agreement to avoid the stress of a possible dispute.

Fourth, the Operating Agreement/Shareholder Agreement needs to be drafted by an experienced corporate/business lawyer who understands the intent of the partners with respect to management and financial matters.  Simply adopting an agreement found online or borrowed from a third party ignores the fact that a pro forma agreement will not capture the intention of the partners regarding key issues, including control, management of the business, financial rights, buy-sell/shotgun clause, and many other issues.

Fifth, the execution of an Operating Agreement/By Laws is an indicia of the intention of the partners to observe the formalities of the business organization, providing an important argument to any claim by a creditor to pierce the protection of the entity and assert claims against the partners individually ("pierce the corporate veil").

Next Installment:  Invention Assignment Agreements/Confidentiality Agreements

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