Five Issues Key to the Success of Closely Held Entities

In the Press · August 1, 2008

When dealing with closely held entities, either corporations or limited liabilities companies, there are a variety of issues that owners and management should consider to help ensure the company’s success. In this article, we’ll discuss the top five. 

1. Formalities

Limited personal liability and the tax benefits of doing business in the company form are available only when the shareholders/members comply with the numerous requirements of corporate law. The benefits flow from the legal recognition of the entity, separate from its individual shareholders, members, directors and officers. To enjoy these benefits, everyone must operate the entity in accordance with certain formal requirements.  It is essential that company and personal affairs be kept separate.  Never mix company and personal funds, assets or accounts. Do not use company funds or assets for personal or other non-company purposes. Business should be done in the company name. Avoid any indication that you are dealing in a personal capacity.  The company name should be used on the telephone listing, advertisements, signage, letterhead and other collateral.  

When signing documents, it should always be evident that you are acting on behalf of the company.   

2. Buy-Sell Agreements/Operating Agreements

Many companies restrict the transfer of securities held by their shareholders or members through a buy-sell agreement or an operating agreement.   

Typically, a buy-sell agreement will cover restrictions on transfers, mandatory repurchase (e.g., when the corporation and/or shareholders must repurchase the corporate stock, such as on the death of a shareholder), optional repurchase (when the corporation and/or shareholders must repurchase the corporate stock, such as on termination of employment of a shareholder with the corporation), and the price and terms of sale (what valuation method will be used to determine the price of the stock and what terms of payment will be required). As part of the review and negotiation of these agreements, each person should carefully review their own estate plan to verify it is current and up to date.  

An operating agreement may cover many of the same issues as a buy-sell agreement, and can include certain rights the members may have when one member elects to transfer his or her member interest.  

3. Securities

The issuance of securities by the corporation is subject to both federal and state securities laws. Although the federal and state definitions of a security are not identical, such definitions are quite broad and include stocks, options, warrants, evidences of indebtedness, investment contracts, and interests in a stock or profit sharing plan. Officers and directors may be held personally liable for criminal and civil violations of securities laws. Therefore, whenever a corporation considers offering, issuing or selling securities, it must be aware of applicable federal and state laws. Also, the corporation should consider "private placement" and "limited offering" exemptions from these laws.  

4. Trademarks, Trade Names and Trade Secrets

If the entity has developed a name or symbol which has or will become associated with the entity’s product(s) or services, and which indicates its unique origin with the company, then the entity may want to register the name or symbol as a trademark or trade name. Registration with the state and, if appropriate, the federal government, will protect the trademark and trade name assets against loss through improper usage and infringement.  If a creative process is involved in the production of the entity’s product(s), then a patent and suitable contractual arrangements might be appropriate to protect and preserve company ownership. Trade secrets can be protected by requiring employees to sign agreements guaranteeing the safekeeping of trade secrets and confidential information. Intellectual or literary property may qualify for copyright protection. Require all key employees to sign a non-compete agreement before they start working.  

5. Exit Strategy

Almost every person involved in the formation of the business should have an exit strategy for his/her departure. The company may be acquired, become a public company or decide to dissolve. The principal shareholders and/or members can accomplish some of the goals by updating the buy-sell/shareholder agreement on a regular basis. In addition, each person should update his/her estate, and make sure to put an adequate succession plan in place.  

Businesses are started with optimism and the hope that they will be successful. Many people do not want to consider the problems that may arise when operating a business. However if everyone involved keeps these five basic issues in mind, the chances of success are greatly enhanced. 

For more information on these issues or other corporate challenges, please contact Robert P. Maloney, chair of the Corporate Practice Group at 617 456 8008 or rmaloney@princelobel.com