Governing Documents for Small Business
Governing Documents for Small Business by Entity Choice in Texas – The Essentials
Governing Documents in Texas are referred to Differently Depending on Entity Type.
When you form a business with another person, whether one or several, you need a written agreement spelling out how the business will be governed and what happens if an owner voluntarily or involuntarily needs to exit the business. In a partnership, such agreement is called a “partnership agreement.” If you have a limited partnership, it may be called an “Agreement of Limited Partnership.” With a limited liability company, the governing document is commonly called a “Company Agreement” or an “Operating Agreement.” If you are a corporation, the governing documents typically consist of “Bylaws” plus a “Shareholders’ Agreement.”
What Matters Should be Addressed in an Entity’s Governing Documents?
Here is a partial, non-exhaustive, list of matters to consider including in your governing documents when you start a company in Texas:
Initial Matters. Recitations should be included regarding the date of formation of the entity with the Texas Secretary of State, the entity name and any assumed names, the duration of the entity, purpose of the entity, principal office, and name and address of the entity’s registered agent. Will the company issue ownership certificates (share certificates, membership interest certificates)?
Initial Owners. The initial owners and their relative percentages (or shares) should be listed.
Withdrawals or Expulsions (Partnerships, Limited Partnerships and LLC’s): Can a member or partner withdraw as a member or partner? Can a member or partner be expelled from the partnership or limited liability company for certain acts or trigger events? If so, what are the voting and economic effects of such withdrawal or expulsion?
Assignment of Ownership. Under what conditions may ownership interests or shares be assigned to other parties? Will assignments be restricted or require the consent of the other owners?
Voting Rights of Assignees. For partnerships and limited liability companies, will assignees of an ownership interest only have economic rights? Will voting rights stay with the assignor?
Admission of New Partners or Members. For partnerships and limited liability companies, what is the voting requirement to admit a person as a new partner or member?
Dilution and Capital Calls. What are the initial capital contributions of each owner, and can the owners be assessed additional capital contributions in the future with respect to their ownership interest? Do all owners have the right to contribute capital pro-rata to avoid dilution?
Encumbrances. Will owners be allowed to pledge their ownership interest as collateral?
Representations and Warranties of the Owners. What representations and warranties are needed between the owners and the Company and the other owners?
Management of the Company. What will be the governing body of the company? For limited partnerships, the governing body is the general partner. For partnerships, it may be a managing partner or managing board. For limited liability companies, it could be the members themselves, a sole manager, or a board of managers. For corporations, the shareholders elect a board of Directors.
Compensation to Company Management. Who will determine the compensation to be paid to the governing body of the company?
Governing Body Meetings. Who can call meetings? When are meetings required? What is the quorum for action at a meeting? What are the voting thresholds for different regular business versus fundamental transactions? Are there any votes that require unanimous consent? Can action be taken without a vote upon if a written consent is signed? Can owners vote via proxy, and if so, what the requirements?
Taxation. If a partnership, the entity will be taxed as a partnership. But if a corporation, the entity may be taxed as a C-corp or elect to be taxed as an S-corp by timely filing the correct election form with the IRS. If the entity is a LLC with more than one member, it can choose to be taxed as a partnership (the default), a corporation or a corporation with a S-corp election.
Distributions. When will distributions be made? Who determines the amount and timing of the distributions? Which assets will be available for distribution? Will distributions be made pro-rata according to ownership ratios? Will tax distributions be made for entities electing S-corp or partnership taxation?
Books and Records. Who can access the books and records of the company? Will certain reports be provided to owners on a regular or annual basis?
Transfer Restrictions. If an owner desires to transfer the owner’s interest, will there be a right of first refusal to purchase in favor of the company or the other owners?
Buy-Out Trigger Events. If a death, divorce, disability (or in the case of an entity-owner, a change of control) occurs, will the company or other members have either an obligation to purchase (in the case of death of an owner) or an option to purchase the affected owner’s interest? How will the sales price be determined? Will the sales price be paid in cash or over time?
“Texas Shoot Out” provision if 50/50 ownership. If the owners will be 50/50 in ownership percentage, consider the pros and cons of adding a provision called a “Texas Shoot Out” that allows either partner to trigger either the sale of the partner’s interest or the purchase of the other partner’s interest.
Tag-Along. Will the minority ownership interests have a right to “tag-along” with the majority interest if the majority interest desires to sell to a third-party?
Drag-Along. Will the majority interest have a right to “drag-along” the minority interest in the event the majority interest desires to sell to a third party?
Conflicts of Interest and Fiduciary Duties. Will the fiduciary duties and conflicts of interest policy for the owners who are governing persons be varied from the statutory and common-law duties?
Indemnification. Will owners and governing persons be paid back (or advanced) their costs and expenses for claims, demands actions or suits involving the company, and if so, what are the limits of that indemnification?
Non-competition. For partnerships, limited partnerships and limited liability companies, will the owners be restricted from competing against the company?
Default. If an owner defaults on its obligations under the governing documents, such as failure to make a capital contribution, what are the company’s and other owners’ remedies?
Winding Up and Liquidation. Who gets to decide to wind up the company, and how is the liquidator chosen? How will the remaining assets of the company be divided after winding up?
Amendments to Governing Documents. What is the vote threshold to amend or modify the governing documents?
At Turney & Espino PLLC, we are business law attorneys in The Woodlands, Texas, focusing on contract law, contract review, contract negotiation, partnership and shareholder matters, and corporate governance. We form businesses, review all types of contracts, represent clients buying or selling a business, and provide general business legal advice. We serve clients in Montgomery County and Harris County, Texas, and are convenient to Conroe, Spring, Tomball, Willis, Magnolia, Woodforest, The Woodlands, and the Houston metropolitan area.
Information on this website is for informational and educational purposes only and is not offered as legal or tax advice. No attorney-client relationship is created, nor may you rely on this information. We seek to keep information up-to-date, but laws may change.