Your Questions, Answered

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When starting a new business, the owners often find it helpful to have a separate business entity, like a corporation or a limited liability company (LLC). A separate business entity can shield the owners from being personally responsible for the debts or liabilities of the business. A separate business entity can also make it easier to grow a business or attract additional owners or investors.

Once a new business entity is formed, there are important limits on how and when owners can act on behalf of the business. Among other obligations, the business must maintain its own assets and accounts. The owners shouldn't mix business assets with their personal assets or treat business assets like their own.

A corporation is owned by its shareholders, who own shares of stock in the corporation. A corporation is usually governed by a board of directors, with its directors selected by the shareholders. In addition to the laws of the state where the corporation is formed, shareholders' rights are typically governed by a shareholder agreement: a contract that determines the shareholders' rights and obligations toward one another.

A limited liability company is owned by its members, who hold units of the LLC. Depending on how the LLC is organized, it may be governed by a board of governors (or directors) selected by its members, but the law doesn't always require one. In addition to the laws of the state where the LLC is formed, members' rights are typically governed by an operating agreement (or limited liability company agreement): a contract that determines the members' rights and obligations toward one another.

When founding a new business, different factors may favor choosing either an LLC or a corporation. An LLC tends to be simpler and more flexible, while a corporation offers more ways to solicit investors. There are also tax considerations that may favor one business entity over the other.

In the early stages, owners may promise you an ownership stake in their corporation or LLC. To protect your rights, it's important that you legally document your ownership.

If the business is formed as a corporation, that may mean receiving a shareholder agreement or other governing documents, as well as agreements that establish your ownership of shares. If the business is formed as an LLC, that may mean receiving an operating agreement (limited liability company agreement) or other governing documents, as well as agreements that establish your ownership of units.

Less formal communications, like emails or text messages, are rarely enough to prove that you hold an ownership stake in a business. Even statements in an offer letter or employment agreement may not be enough. If you're not sure about whether you have enough documentation to establish your ownership stake, or if you have questions about your rights as an owner, you should consult a qualified attorney.

There are unusual circumstances where informal communications can potentially be enough to establish your ownership stake. Even when there's no LLC or corporation, courts will sometimes imply the existence of a partnership or joint venture, recognizing that the stakeholders have ownership rights. But it's better to have legal documentation that formalizes your rights and interests as an owner.

Your employer may offer other benefits that seem like stock or ownership interests. Those benefits can include things like stock options, restricted stock units (RSUs), phantom stock, profit interests, and equity participation units.

Stock options generally provide you the option to acquire or purchase stock in a corporation at some point in the future. Through the exercise of a stock option, you can potentially become a shareholder. But that's not always the case. Depending on how stock options are legally structured, you may not receive stock at all, or you may receive a cash payout instead.

Restricted stock units (RSUs) generally mean that you acquire the right to stock, or something of equivalent value to that stock, after a specified vesting period. Like with stock options, you can acquire stock through the vesting of RSUs, but that's not always the case. After RSUs are vested, the company usually can choose between granting stock or a cash payout.

Phantom stock and profit interests aren't ownership interests at all. They don't make you an owner or shareholder in a corporation or LLC. If your employer grants you phantom stock or profit interests, that typically means you receive a payout based on the profits or growth of the company.

Equity participation units are also typically structured in a way that functions like phantom stock or profit interests. Under most circumstances, you don't receive any ownership interests. You may instead receive a payout based on company profits or earnings; or a payout based on the value of company stock or dividends.

If you're receiving stock options, restricted stock units, or other forms of equity participation, you can't assume that you'll become an owner or shareholder. Your rights and obligations may be very different from those of owners or shareholders. If don't receive legal documentation that explains what you're getting, or if you aren't sure what you're getting, you should consult a qualified attorney.

For more details about stock options and other forms of equity participation, visit my site's Stock Options and Equity Participation page.

Your rights and obligations will usually depend on two important considerations: the law of the state where the LLC or corporation is formed; and the shareholder or operating (limited liability company) agreements that contractually define the owners' rights and obligations toward one another.

As a general rule, if you're a member or shareholder in the business, you have the right to basic information about the business, like its books and accounts. You may also have the right to vote on certain types of major business decisions, such as the selection of executives or board members. But a shareholder agreement or operating agreement can significantly restrict these rights or place additional requirements on how you exercise them.

An LLC or corporation may also have different classes of ownership. For an LLC, that may mean different classes of ownership units; for a corporation, that may mean different classes of stock. Many startups have different classes of ownership for investors versus employees. 

When there are different classes of ownership, some classes may have voting rights and others may not. Some classes may favor investors, granting them certain rights or privileges. If the business is sold or taken over, the holders of investor-class stock may need to be paid off before others receive a share of the sale proceeds.

If you aren't sure about your rights as a shareholder in a corporation or as a member of an LLC, or if you think that your rights are being violated, you should contact a qualified attorney for further guidance.

As a general rule, when members of an LLC or shareholders in a corporation exercise control over the business, those members or shareholders have fiduciary duties toward the other members or shareholders. While it's not possible to completely summarize those fiduciary duties here, there are some important aspects of fiduciary duty it can be helpful to know about.

One commonly recognized fiduciary duty is the duty to exercise reasonable business judgment. If those with control over the business don't exercise reasonable business judgment, then noncontrolling owners can potentially bring legal action. But these types of lawsuits are rare, have complex technical requirements, and typically involve very careless business practices.

Another commonly recognized fiduciary duty is the duty of loyalty. This duty requires owners to act in the best interests of the business and not wrongfully divert business opportunities to themselves or outsiders. This duty sometimes means that owners can't set up their own competing businesses, or that owners can't use the business to make deals with themselves or others for less than fair value.

If one owner engages in "self-dealing" or other transactions that create a conflict of interest with other owners, that can sometimes create legal claims against the owner who engaged in the wrongful transactions. But some states permit legal agreements that can waive conflicts of interest or allow self-dealing transactions. If you suspect that a member or shareholder is engaged in these types of problematic transactions, you should consult a qualified attorney about your options.

In many circumstances, the majority owners of an LLC or corporation will have enough authority or voting power to make all significant decisions for the company. But in most circumstances, the majority owners can't use that power to "oppress" minority owners, by taking actions that harm the minority or diminish the value of their ownership interests. If you're a minority owner who believes that the majority is taking actions against you, that may be another situation where you should consult a qualified attorney.

As the prior question and answer shows, you may also have fiduciary obligations toward other owners of an LLC or corporation. Those obligations are often the same as those of other owners, but not always. 

Sometimes fiduciary duties can be waived or modified by a shareholder agreement or an operating (limited liability company) agreement. If a corporation has multiple classes of stock, your rights and obligations may depend on what class of stock you hold.

As an owner of an LLC or corporation, you may be bound by a fiduciary duty of loyalty. To comply with that duty, you can't engage in competing activities or divert the company's business opportunities to others. There can be exceptions, but they're rare. They typically require specific language in a shareholder or operating (limited liability company) agreement, or some other form of legally valid permission.

If you're an owner and an employee, the duty of loyalty can create additional problems. Let's say you have an employment agreement with noncompete terms. Even if the employment noncompete is completely invalid, as an owner in the company, you may also be subject to the duty of loyalty. Like a noncompete term, the duty of loyalty may prevent you from engaging in some types of competing activity. 

Sometimes fiduciary duties can be waived or modified by a shareholder agreement or an operating (limited liability company) agreement. If a corporation has multiple classes of stock, your rights and obligations may depend on what class of stock you hold. If you're not sure about the scope of your fiduciary duty of loyalty, or what types of activities might violate that duty, you should contact a qualified attorney for further guidance.

If you own shares in a large company that's traded on a public exchange, then in most circumstances, you can buy and sell those shares without others' permission. 

But if you own shares or units in a "closely held" or "privately held" company (anything not publicly traded), there will almost always be significant restrictions on how and when you can sell. These restrictions are often found in the shareholder agreement or operating (limited liability company) agreements that govern the owners' relationship with one another. If the company has multiple classes of stock, there may be additional restrictions depending on what class you hold.

You may need permission from others, either the board or other owners, before proceeding with the sale. You may need to follow an appraisal procedure for determining the value of the company and the proportionate value of your stake. There may also be limits on who you can sell your stake to. For that matter, you may not be able to sell your stake at all.

If your company only has a few owners, another possibility is to negotiate a deal with them. In this scenario, it's usually best for each owner to be represented by their own attorney. A qualified attorney can assess whether your interests are protected and that any deal complies with prior agreements and governing law.