In January 2021, Ohio enacted a significant, comprehensive revision of the Ohio Limited Liability Company Act, which will go into effect on January 1, 2022. The new LLC Act offers an excellent opportunity to review the procedures for starting a business in Ohio, as well as the documents necessary for daily business operation.
The types of governing documents your business will need depends on your business’s form – limited liability companies (LLCs) will have different governing documents than corporations, etc. No matter what type of business you are starting, in addition to the organizational documents you must file with the State of Ohio (articles of organization or articles of incorporation), you should have some variation of the following documents.
Operating Agreement/Shareholder Agreement
Who Needs an Operating Agreement?
An operating agreement is an agreement between the members of an LLC delineating internal operating procedures, including how decisions are made and by whom. Ohio does not require operating agreements for LLCs; however, it is still advisable to have one, whether your LLC has one or several members.
Operating agreements for multi-member LLCs include all valid written and verbal agreements between the members. For a single-member LLC, the agreement must be a written declaration.
Because operating agreements are not required, you do not need to file your operating agreement with the state. You should, however, keep your operating agreement with your other critical business documents.
What is in an Operating Agreement?
There are no specific requirements for the contents of an operating agreement. However, it is common to include at least the following:
- LLC Organization: identify the initial members of the LLC, along with their ownership percentages.
- Capital Accounts: detail any initial capital contributions by the members, any requirements for future capital contributions, and procedures for returning capital contributions.
- Allocations and Distributions: outline procedures for allocating profits and losses, distributions of cash flows, and distributions in the event of a capital transaction or liquidation.
- Voting: outline procedures for voting on issues and voting power of each member.
- Management: outline procedures for day-to-day management of the LLC, including whether members or others are in charge of management functions; responsibilities of the members and any identified managers of the LLC.
- Membership Changes: outline procedures for admitting new members, expelling members, and member withdrawal, including restrictions on transfer.
- Amendment: outline procedures for revising the operating agreement
- Dissolution: outline procedures for winding up the business, including how to deal with outstanding debts and accounts and distribution of assets.
Because your operating agreement contains financial information for LLC members, you should include confidentiality provisions during drafting.
Why Should You Have an Operating Agreement?
An operating agreement serves to protect the LLC in several important ways. First, operating agreements help prevent conflict among the members of an LLC by specifying how the LLC will handle given situations.
Operating agreements also allow the members to define their rights and responsibilities rather than subject the LLC to the state code’s default rules. The recently restated LLC Act (now codified in Ohio Rev Code § 1706) contains the default provisions that apply in the absence of specific operating agreement provisions, as well as deviations from the state code that are not allowed to be modified by the operating agreement (Ohio Rev Code § 1706.08).
Significantly, an operating agreement can also protect the business’ limited liability status. Absent an operating agreement, businesses risk treatment as partnerships or sole proprietorships, potentially exposing members to personal liability.
Code of Regulations and Bylaws
Who Needs Codes of Regulation and Bylaws?
Non-LLC corporations adopt codes of regulation (or bylaws) rather than operating agreements. While they can be treated differently, with codes of regulation addressing day-to-day business operation and bylaws addressing the operation of the board of directors, they are often consolidated into a single document. Ohio does not require corporations to have bylaws or codes of regulations; nonetheless, your corporation should have in the corporation’s governing document in writing to ensure the business’s smooth governance and operation.
What is in the Code of Regulations/Bylaws?
Corporation regulations and bylaws define the corporate structure and daily operating procedures for the business, as well as the operation of the board of directors. Standard provisions in codes of regulation/bylaws include:
- Identification: state the corporation’s name and provide contact information
- Officers and Directors: specify the number of officers and directors of the corporation; should preferably also include qualifications, responsibilities, selection processes, terms of office, compensation and removal; unlike operating agreements, bylaws need not specifically identify the officers and directors
- Ownership: detail the types of shares the corporation issues and procedures for issuance
- Meetings: detail procedures for holding director and shareholder meetings
- Corporate Recordkeeping: The procedures for keeping corporate records
- Amendment: detail procedures for revising the code of regulations/bylaws
- Share Transfer: detail any restrictions on share transfer
Why Should You Have Codes of Regulation/Bylaws?
Just as with operating agreements, corporate governance documents are essential to minimize both internal issues and issues between corporate management and shareholders. Governance documents also give the corporation the maximum degree of control over its operation, rather than relying on state default provisions.
Buy-sell agreement/succession planning
Who Needs Succession Planning Documents?
Every business should have succession planning documents to protect the interests of owners in the event of an owner’s death, disability or desire to transfer ownership interests. Although operating agreements or bylaws may address succession planning, many closely-held corporations elect to have a separate buy-sell agreement.
What is in Buy-Sell Agreements?
Buy-sell agreements define the conditions under which owners can, or in some cases must, sell their ownership interests. In addition, they often include specific rights of refusal for the remaining owners regarding the purchase of the transferring owner’s shares. Buy-sell agreements keep company ownership within a given, desired set of individuals.
The specific content of a buy-sell agreement depends on the form of the agreement. Buy-sell agreements typically take one of three forms: stock redemption agreements, cross-purchase agreements, or a hybrid of the two.
Redemption agreements provide that the business as a whole will purchase the shares at issue. Cross-purchase agreements allow individual owners to purchase shares, typically on a pro rata ownership basis. Hybrids give first rights to the company, followed by an offer to individual owners.
Why Should You Have Succession Planning Documents?
Succession planning documents ensure that you are not forced into business with an unintended or undesired partner. By providing the business or its existing shareholders the first opportunities to purchase shares from a departing shareholder, you ensure management and ownership continuity.
Without comprehensive succession planning documents in place, the company may be exposed to significant litigation risks in the event of a shareholder departure.
This article is meant to be utilized as a general guideline for governing documents for businesses. Nothing in this blog is intended to create an attorney-client relationship or to provide legal advice on which you should rely without talking to your own retained attorney first. If you have questions about your particular legal situation, you should contact a legal professional.
Please contact Gertsburg Licata, home of CoverMySix®, for more information about our anti-litigation audit services, including an assessment of your governing documents. At Gertsburg Licata, we help you through the legal challenges facing your business, so that you can focus on making it grow. We invite you to call 216-573-6000 or fill out our contact form, for a complimentary consultation with one of our attorneys.