What are the key differences between a shareholder agreement and an operating agreement?

No matter what size your company is currently, if there are multiple people invested in the running of your business, it’s imperative that there be a comprehensive agreement in place that dictates things like who runs the business on a daily basis, what happens if one of the shareholders becomes incapacitated or dies, and who takes over if a person decides to retire.

The very last thing you as a business owner want is for the business you have built to fall apart because its shareholders cannot come to an agreement about how the business should be run. Let’s take a look at what shareholder agreements are, how they differ from operating agreements, and why they are so important to have in place.

What is a shareholder agreement?

A shareholder agreement is an agreement forged between the various owners of a small business that defines the relationship between each of the owners. Shareholder agreements usually constitute a contingency plan for what happens when an unexpected event happens, like if one of the owners becomes incapacitated or passes away, or decides to retire.

These agreements also create some restrictions on what shareholders can and cannot do. In most cases, shareholders cannot sell their share in the business to a third party who was not originally part of the business but may sell their share to another existing shareholder if that shareholder is willing to buy the other one out.

Just like planning ahead for incapacitation and death in your personal life, it’s important to plan for unforeseen events that may occur between owners of your business. Planning ahead is imperative for a business’s wellbeing and survival, and will also allow you to enjoy doing what you love – running your business – rather than worrying about what might happen if an unexpected event occurs.

What is an operating agreement?

In many ways, an operating agreement is similar to a shareholder agreement, with the key difference being that operating agreements are designed specifically for limited liability companies, or LLCs. Shareholders are referred to as “members.” The operating agreement will define the relationship between each of the LLC’s members, and outline what happens if one of the members retires, becomes incapcacitated, or dies.

Like shareholder agreements, operating agreements allow for a member to buy out another if one member decides to leave the company. There are a limitless number of arrangements that can be made between members of an LLC, including how profits are dispersed among members, who manages the company, how conflict between members gets resolved, and what members are prohibited from doing, such as transferring ownership to a third party outside the LLC.

The Bottom Line

The point of both shareholder and operating agreements is to eliminate uncertainty within companies when multiple parties involved. These agreements can protect your business from unnecessary strain and even from financial ruin because all parties have agreed to the same terms and contingency plans. It’s extremely beneficial to hire an experienced attorney to help you set rules and navigate the various arrangements between you and your business partners in a way that works for everyone. Please contact the North Carolina corporate attorneys at Mullen, Holland & Cooper for a consultation when you’re ready to get started.