Embrace the Legal Structure of Your Business

Why should business owners embrace the legal structure of their business?

This article applies to corporations, limited liability companies, even partnerships. Any legal structure where there are two or more owners.

What is the “legal structure” of a business?

I know, this starts out like an AI wrote the post. It didn’t (it was mentioned to me today that my posts sound like I actually wrote them – strange world we’re creating here). Anyhow, the legal structure of a business sets out several simple things, although they can get complicated in the execution.

The legal structure of a business should be a document or related documents setting out three basic items for the owners: where does the money go; who has authority to determine the direction and decisions a business makes; and what happens when the business closes or is sold. Anything other than that is a bonus. Not in order of importance:

Legal Structure Determines Who Gets the Money

First off, the legal structure should set out how profits and losses are allocated. This can mean dividends in a corporation; or distributions in an LLC or partnership. In a corporation it’s simple. Each shareholder gets one share of the profits for every share owned. If there are a hundred shares, and you own ten, you get 10/100 of the profits.

In an LLC it can get more complicated, but it doesn’t have to. In an LLC decision making and distributions, discussed in a minute, can be separated and apportioned however the owners want to. Differently than a corporation, LLC owners need to explicitly state what the percentage share of profits will be. That can be expressed as “shares” like in a corporation. It can also be simple percentages, e.g., “Bob gets ten percent of the profits”. But it needs saying out loud. Otherwise, profits are determined by the statute which defaults to equal shares.

Who Makes the Decisions

Your legal structure should also set out who makes what decisions. That is, who has the authority to bind the company, set its direction, manage the day to day of the business.

Corporations have a standard authority structure: shareholders, directors, officers. But within that there is overlap and, as I’ve seen with poor drafting, uncertainty. When I draft bylaws for a corporate legal structure, I set out what role each of these three groups play in the decision making.

Short version (I’ve blogged about it before): shareholders elect directors, and may vote on liquidation (or sale) of the business. Directors set the “direction” the business will take (see how they are the same word?) and appoint officers. They also make major spending decisions. Officers execute the direction of the directors (thus, chief “executive” officer – the words are the same again!).

In an LLC this structure is truncated because an LLC only has “members” who can also be managers (officers). However, it’s good practice in a multiple member LLC to set out spending and contracting limits for managers before they need to get the consent of the other members. You don’t want to invest $500k into an LLC only to have the manager show up to work two days later driving a new Cadillac with your money. Authority comes from permission. Make it explicit.

legal structure
Michael Palermo Business Lawyer

Dissolution of the Business

Hopefully you’re selling the business at a profit (a kind of liquidation). Whether that, or liquidating and shutting down, or entering bankruptcy, there may be a final distribution of the remaining assets of the business, or the profits from the sale.

In a corporation it’s easy: one share equals one share.

In an LLC, however, liquidation distribution rights can be, again, separated from profit distribution rights. Someone who injects $500k into a faltering LLC may demand not only repayment of that money on liquidation, but also a premium on the remaining monies from the liquidation. He helped the business survive when it was desparate, after all. The permutations on distributions in an LLC are whatever you can imagine.

Why Are We Doing This?

If everything is on paper, well drafted, and agreed to beforehand, then everyone can just refer to the bylaws or operating agreement when there are questions about decision making, profit and liquidation distributions. That’s what I mean by “legal structure” of the business. Well drafted, easily understood operating documents.

Are You Embracing the Legal Structure of Your Business?

Contact me for help setting up and operating the legal aspects of your business. In western North Carolina, Asheville, Waynesville, Hendersonville at (312) 671-6453.

Email me at: palermo@palermolaw.com.

Be sure to check out my other blog posts HERE.  Be sure to listen to my podcasts with Matt Mittan RADIO PROGRAM or at BizRadio.US