Business Breakups and Partnership Prenups (Revisited)

Business Breakups and Partnership Prenups (Revisited)

Not too long ago we discussed how to choose the right business partner, how to navigate business breakups, and the ins and outs of partnership “prenups”. But what if your “partnership prenup” (i.e., your operating agreement, partnership agreement, bylaws, or shareholder agreement, depending on your corporate structure and entity type), hasn’t been updated in a while? What are some signs you should look out for that signal that it’s time to revisit it, give it a refresh, or scrap it altogether?

Your governing documents are not a formality, particularly where there are multiple owners involved. It is a living document that needs to evolve with your business. As things change, your agreements need to reflect those changes. Otherwise, you leave your business (and potentially yourself) vulnerable to partnership disputes, tax issues, and just general legal headaches/surmounting legal fees.

Let’s dive right in, shall we? Here are 3 signs that it’s time to update your governing documents, whether it’s your operating agreement, partnership agreement, shareholder agreement, or bylaws.

Sign #1: You Have No Clue What it Says

It happens. Maybe you ordered a quick template online, or used all the skills you gained by watching Suits and threw something together when you first started your business. Years pass, you stuff it in the bottom of a drawer or filing cabinet and never really look at the darn thing. Tomorrow’s problem turns into today’s headache. Chances are, there’s something missing that is critical to your ownership arrangement and corporate structure, or there’s something random and potentially problematic in there. There’s only so much you can control in business, but understanding the contracts you sign, particularly the contractual blueprint for your business, is something you certainly can and need to be in control of. One example we see often: when drafted at the start of the partnership, you didn’t address partner exits. Now, 10 years later, that’s something the partners are discussing. What terms govern?

Sign #2: You Recently Issued Equity or Changed Owners

A key component of your governing documents is the business’s ownership structure, including entitlements to distributions and voting rights. If you’ve recently changed owners, sold or diluted someone’s ownership interest, or issued additional equity, your governing documents must always reflect the current ownership structure. Failing to keep them updated can, and likely will, expose you to legal disputes over unwritten expectations. Handshake deals just won’t do it folks. Update your member schedule, update your cap table, and revisit this information immediately upon a change and on a periodic basis. Another example: Bill owns only 10% of the business, but you haven’t updated the documents to reflect how voting is governed or decisions are made. Does Bill have a say?

Sign #3: You’ve Experienced Significant Growth Overall

On that note, the bigger you are, the more likely that you’ll need additional guardrails on ownership (i.e., dividing equity holders into classes), distributions, and transfers. For example, if you have dozens of shareholders, do you want them all to have free rein over buying and selling shares from each other, or selling their shares to random third parties? Did someone say hostile takeover? Ouch.

Growth isn’t limited to investors, shareholders, or members. Once you start adding to your business’s scope, take on larger clients, have a more significant presence, and update your tax plan, your agreement needs to catch up. When you started as a new entrepreneur, you were likely in survival mode. Maybe non-competes and confidentiality didn’t matter as much. But what happens when you develop the next TikTok? Is that protected? What if one of your members withdraws and opens up shop right next door, selling exactly what you sell, to pretty much all of your clients? And here’s another hypothetical for good measure: what if you die? Mic drop.

In any event, it’s a good idea to revisit your governing documents every couple of years, just to make sure that they are not only legally compliant, but keep up with your ever-evolving business.

This is all food for thought, but overall, the most telling sign is your gut. That nagging feeling that you may or may not have right about now, telling you to take another look at your corporate documents? Trust it, that’s your business instincts talking, and as always, if you’ve got questions, you know we’ve got answers!

~ The W + K Team