The following article originally appeared in the April 2014 edition of The Myers Report newsletter published by the firm.
Update Your Corporate Records Now to Avoid Problems Later
By: James E. Robinson, Esq.
Record keeping and attending to legal formalities aren’t always at the top of the to-do list for the owners of small to mid-sized businesses. In part, it’s human nature – compliance with legal requirements isn’t always fascinating or fun to attend to (actually, that’s almost never the case); and in part it’s simply a matter of practicality – running the business has to come first. There are, however, important reasons to keep your business records up-to-date. In this article we discuss some of the most important types of business records and the benefits of making sure that they’re properly maintained.
The “Corporate Book”
Most closely-held private corporations and limited liability companies in New York (including those of the professional variety – PC’s, DPC’s and PLLC’s) have a record book of some sort, often a loose-leaf binder in a sleeve. The record book serves as a central location to store and preserve important company records, including: the certificate of incorporation, articles of organization, filing receipt and/or other documents evidencing the formation of the company; the by-laws or operating agreement setting forth the rules by which the company will be run; the minutes of meetings and votes of the company’s owners and management; and a transfer ledger or other record of the ownership of the company and the stock certificates or membership interest certificates that have been issued over time. Technically, corporations are supposed to hold a meeting of shareholders at least once a year, and there should usually be at least one meeting of the board of directors each year (often taking place in conjunction with or shortly after the meeting of shareholders). The meeting schedule for limited liability companies is largely left to the owners’ discretion, but with respect to both corporations and limited liability companies there are likely to be discussions and decisions concerning important business matters that take place from time to time and the best practice is to memorialize these discussions and decisions. It’s not uncommon, however, that the record book is never filled out or that, after initially being filled out, its use falls off over time and it ends up gathering dust on a shelf.
When does the record book become important? The most common occasions are when the company seeks financing or when the business is sold. In these instances, the bank or the purchaser, as the case may be, will want to review the company’s records in order to confirm who the owners are, that there have been proper votes by the owners and/or management authorizing the transaction, and that the officers or other persons who will be signing documents on behalf of the company are authorized to do so. Fortunately, there’s often a good amount of lead time associated with these types of transactions, so the record book can be put in order and brought up-to-date if necessary.
Unfortunately, not all events can be planned for. It’s uncommon, and not pleasant to contemplate, but the fact is that there can be unforeseen changes in circumstances – as, for example, where an owner unexpectedly dies or becomes disabled. At that point, it’s too late to fill in any gaps in the company records and if the owners (or the spouse or family of a deceased or disabled owner) have different ideas about who owned what, how much the company is worth or any of a variety of other issues, then disputes may arise and there may even be lawsuits. Not every problem can be avoided, and most people don’t have perfect records, but while you have the opportunity it’s worth thinking about what the important facts concerning the ownership and management of your company are and whether they’re clearly documented.
If your business has more than one owner, then a buy-sell agreement – an agreement that sets forth the circumstances in which an owner’s interest may be sold or will be bought out – is something that you should consider putting in place. The desire to have buy-sell arrangements in place is one of the principal motivations for the shareholders of a corporation to enter into a shareholders’ agreement. The members of a limited liability company are required by law to enter into an operating agreement which describes the basic procedures for running the company, however the members often decide to supplement the agreement with provisions concerning the purchase or sale of membership interests in the company.
A buy-sell agreement typically addresses a variety of circumstances in which an owner’s interest in the company might be bought or sold. These may include: an owner’s desire to sell all or part of his or her ownership interest, an owner’s retirement, the disability of an owner and/or the death of an owner. The agreement allows the owners to plan for and agree upon what will happen in each circumstance. For example, if an owner wishes to sell his or her ownership interest, then he or she may be required to first offer it for sale to the other owners before being permitted to sell it to an outside person. As another example, it’s not uncommon to agree that if an owner retires, becomes disabled or dies, then the other owners will be required to purchase his or her interest.
A buy-sell agreement also serves to establish the terms for a sale. The most important term is the price, which may be determined in a variety of ways as further discussed below. Other important terms include the manner in which the purchase price price will be paid (whether in a lump sum or over time, and if over time, the number and frequency of the payments that will be made); what documentation will be exchanged in connection with the sale; and what the seller’s remedies will be if for some reason the purchaser fails to make some or all of the required payments of the purchase price.
Not every business requires an agreement that covers a wide variety of contingencies, but there are some eventualities that are likely to affect most businesses at one time or another. These include an owner’s deciding that he or she wishes to leave the business, an owner’s reaching retirement age, or the death of an owner. Sometimes such a situation will arise suddenly and unexpectedly, and this can lead to problems if the parties haven’t thought about what they’d like to have happen. Taking some time to plan ahead can go a long way toward reducing the possibility that a dispute, or even litigation, could arise in the future. Even if you already have a buy-sell agreement, it would be worthwhile to get it out, review what was agreed to in the past, and consider whether there have been any changes in circumstances that suggest a need to update or modify the agreement. We have available on our website an article that discusses in greater detail the benefits of a buy-sell agreement. That article can be found here: http://jmmpc.com/articles/the-top-5-reasons-a-buy-sell-agreement-is-essential-for-your-business/
Business Valuation Provisions
As noted, buy-sell agreements contain provisions concerning the manner in which the value of the business will be determined in the event that the interest of one of the owners is to be bought or sold. These provisions can take a variety of forms: some call for a formal appraisal, some specify a formula based on revenues, profits and/or other financial measures, and some simply state that the parties will agree upon the value of the business and update that value from time to time. The last method has the advantage of being very simple, but it’s subject to the reality that many people tend to procrastinate or forget to update the value of the business regularly. If the value becomes outdated and unrealistic, and a situation such as death or retirement then arises, it may be very difficult at that point to come to an agreement and avoid dispute because the parties will have differing interests. Accordingly, business owners who have entered into this type of agreement would do well to check on their agreements and make sure that they’re up to date. Even if your agreement is of a different type, a periodic review of the valuation provisions to determine whether they need to be updated is prudent. By way of example, agreements calling for an appraisal sometimes designate a specific person or company to perform the appraisal and it may turn out that the named person or company is no longer in business; and where agreements specify a formula for valuation, it may turn out that the chosen formula is no longer appropriate in light of changes in the business or in accepted industry standards for valuation.
The bottom line with respect to these and other types of business records is that spending a little time now might help you to save a lot of time and expense later. If you have questions or would like assistance in reviewing or updating your business records, then we would be happy to speak with you.
Approximately once a month we publish The Myers Report, an e-mail newsletter containing articles similar to this one that we believe will be of interest to our clients, colleagues and friends. If you’d like to receive The Myers Report then please click here to add your e-mail address to our mailing list.
Please note that this article is intended only as a general discussion and that it should not be taken as creating an attorney-client relationship or as legal advice with respect to any particular person, business or situation. Circumstances and the applicable legal principles vary and you should consult with an attorney regarding any questions you may have regarding your specific situation.