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Your Shareholder Agreement May Not Say What You Think It Says

Disputes between business partners are often won and lost on the documents.

Of course, if the dispute with your business partner involves fraud or theft – a shareholder or partner who has been stealing from the company, or enriching himself unfairly with excessive bonuses – the company’s financial documents will be critical to proving your case.  General ledgers and check registers will (or should) show where the money went.  Bank records will also likely yield a paper trail. More often than not, the existence of those records is not in dispute.   Rather, the argument arises about what those documents mean.

The records I am referencing are much more basic, and can point to the very core issues about the relationship between the owners.  For example, many owners of closely held businesses do not even realize that there are no documents establishing the very existence of their ownership.  In one case I have seen, a member of an LLC stated that the K-1’s issued by the accountant over the years were a “mistake,” that the minority member of the LLC was not even a member, and was lying about his ownership interest.

While this may be an extreme example, a more common one is where shareholders have an understanding amongst themselves regarding how they govern their relationship, but it was never reduced to writing.  Multiple owners operating a corporation without a Shareholders’ Agreement, or an LLC without an Operating Agreement, can lead to disastrous consequences.

In one case, a minority shareholder claimed that he was entitled to serve on the Board of Directors at all times.  For over ten years this was not an issue, as he and his fellow shareholders (his two brothers) had always gotten along.  When the economy turned sour, the business hit a rough patch.  The relationship between the owners became strained and the 1/3 owner was removed from the Board.  When I asked to see the Shareholders’ Agreement that set forth his right to always serve on the Board, he dug deep into his batch of ten year old papers and came up with a Shareholders Agreement that said exactly what he thought it did – but it was unsigned and unenforceable.

It is amazing to hear how many closely held business owners either have no essential documentation, such as a shareholders agreement, or documents that are sorely outdated, such as an agreed upon valuation that is a decade (or more) old.  It is downright scary to hear how many such owners think they have proper documentation, but truly don’t.

Protect yourself.  Inventory what documentation you have.  And if you do not have documentation that protects you and states what you think it should, you should see an attorney about updating the company records.  It may not be too late to make sure you don’t get stuck spending a fortune to prove what you know to be the truth, when a suit between the business owners inevitably arises.