Ask a small business owner whether they have an operating agreement or shareholder agreement, and many will say yes. Ask them when they last read it, and the answer is usually “when we signed it,” often years or even decades ago. These foundational governance documents are among the most important legal instruments a business can have—and among the most neglected. The consequences of neglect tend not to surface until a crisis: a co-owner dispute, a buyout negotiation, or a prospective sale of the company.
What These Documents Actually Do
An operating agreement (for LLCs) or shareholder agreement (for corporations), among other things, governs the internal relationships among the owners of a business. It establishes how major decisions are made, how ownership interests can be transferred, what happens when an owner wants to leave, how disputes are resolved, and what rights minority owners have relative to the majority. Without a well-drafted agreement—or with one that was put together hastily at formation and never updated—you are leaving enormous questions unanswered that can have serious financial and legal consequences when they eventually arise.
The Provisions Most Often Missing
In M&A transactions, a few provisions in governance documents are particularly important. Drag-along rights allow a majority of owners to require the minority to participate in a sale of the company on the same terms, preventing a small minority owner from blocking a transaction that the majority has agreed to. Tag-along rights protect minority owners by entitling them to participate in a sale by a majority on the same terms. Buy-sell provisions govern what happens when an owner wants to exit or when the owners reach a deadlock—establishing a mechanism for pricing and purchasing that owner’s interest without litigation.
Why Outdated Agreements Create Deal Problems
A buyer acquiring a business will review the governing documents carefully. Gaps or ambiguities in those documents—particularly around transfer restrictions, consent rights, and change-of-control provisions—create risk that buyers price into their offers or use as grounds for negotiating deal protections. A shareholder agreement that requires unanimous consent for any transfer of ownership, for example, means that a single minority owner can hold up or block an acquisition. Identifying and addressing provisions like this before going to market protects both the deal timeline and the seller’s negotiating position.
When to Review and Update
Your governance documents should be reviewed whenever there is a material change in the business: a new owner joins, an owner exits, you bring in outside investment, or you are beginning to think seriously about a future sale. At minimum, have experienced counsel review your operating or shareholder agreement every three to five years to ensure it reflects current law, current ownership, and your current intentions.
Governance documents are not glamorous, and they are easy to defer. But they are the infrastructure on which every major ownership event in your company’s life will depend. Investing the time and resources to get them right—before a deal is on the table—is one of the highest-return legal investments a business owner can make. Our Business, Mergers, and Acquisitions lawyers at Beresford Booth can help ensure your governing documents are on track. Contact us at info@beresfordlaw.com or (425) 776-4100 to see how we can help.