The Importance of Corporate Governance Documents and Establishing the Rules of the Game

In early stage startups, the founders often share a strong existing bond: college roommates, siblings, couples, best friends, etc. They are excited about the business idea and can’t wait to make their project a reality.

The farthest thing from anyone’s mind at this point is what happens in the event of a dispute among the founding partners.  Nothing, it seems, could ever go wrong!

… and then, something goes wrong…

In case you are thinking that this can’t happen to you, I’ll give just a few basic examples of issues that drive many partners to litigation:

  • One of the partners opens a competing industry in the same industry and even steals away some customers;
  • An unexpected bill arrives from the start-up’s landlord but one of the LLC members refuses to fork over his or her share of this additional required funding;
  • One of the partners transfers his shares to his friend without notice, and none of the other partners get along with this new partner;
  • The cofounder who received shares up front based on her unique design skills stops showing up to work (but still has her shares!)

From the above examples, you probably realize that you are not as shielded from potential disputes as you thought you were.

How the dispute will be resolved will depend largely on whether the entity has corporate governance documents in place, and whether those corporate documents are thorough and properly drafted.

In my experience as an attorney, I have seen costly disputes break apart even the closest business partners, forcing them to spend tens of thousands of dollars of their personal money on litigation.  Many times, this litigation may have been avoidable had a proper set of corporate governance documents been in place from the start.

To avoid these types of disputes, an LLC may wisely opt for an operating agreement sets forth the rights and obligations of that LLC’s members and managers.  Similarly, a corporation may have a shareholders’ agreement and bylaws, defining the relationship between the shareholders, and establishing the structure of the corporation.

With precise outlines of rights, duties, and obligations, a litigation scenario may be resolved simply by looking up the specific issue within the operative document.

If problems can be so easily resolved, why is it so common to avoid corporate governance documents?

Often, the decision to forego corporate documents is made with a view towards minimizing legal fees.  However, the legal fees needed for a set of operative documents are far more predictable and limited than legal expenses that are normally incurred in litigation.

Contact our law firm for a legal consultation on how your startup can benefit from operative documents.