July 25, 2011

Have you been putting off the tedious task of establishing day-to-day operating procedures for your small business? Are you ready to fund your business and apply for financing? Maybe you are interested in bringing on new business partners or investors. If so, you should consider developing corporate bylaws sooner than later.

Although some states do not require a company to have written bylaws, there are six reasons why every business owner should invest in a strategically thought out set of bylaws for their company:

1.  The Bylaws are the Company’s Legal Backbone.

A company’s bylaws provide the framework for how it operates, including rules for the owners’ relationship.

2.  What if Your Company Does Not Have Bylaws?

If your company does not have bylaws in place, the laws of your state could control how the company is run.  It is much better for the owners to determine how it would like to have the company operate than to rely on the state’s statutes.

It is similar to an individual not having a will or trust.  If they die, the state’s statutes determine how the individual’s assets are distributed.  Instead, the individual should thoughtfully think through how they would like their assets distributed and to set up the legal mechanism to enforce their plan.

Similarly, it is much better for business owners to strategically think through how they would like their company to operate than to rely on the state’s statutes, which might not always be the best fit for the company.

3.  Bylaws Provide Owners With Piece of Mind.

Every company eventually runs into challenges.  It is better to consider some of the potential turning points in your company and provide in the bylaws how you would like for the outcomes of these situations to be determined than to wait to make these tough decisions when interested parties and passions may create the perfect storm for litigation.

For example, what will happen if there is a legal dispute between the owners?  Do you want the company to be tied up in the expense and distraction of litigation or would you prefer arbitration?  What happens if one of the owners dies?  What if one of the owners wants out of the company?

The bylaws present an opportunity to calmly and objectively reflect on these issues before they occur.  It is wiser to answer these types of questions ahead of time and determine what might be the best solutions for your company than to rely on the default rules in the state’s statutes or to try to resolve them when clear heads are less likely to prevail.

 4.  Bylaws Help Protect Your Company’s Limited Liability Protection.

One of the primary reasons to form a corporate entity is to possibly have personal limited liability from the potential business debts and judgments against your company.

If a company does not have bylaws and is sued, a plaintiff could try to “pierce the corporate veil” by claiming the company should not be provided with the shield of limited liability protection because its owners did not follow corporate formalities.

In determining whether to pierce the corporate veil, the court would evaluate a number of factors to determine whether your company is legitimate, including whether you have the proper corporate documents and records.  By not having bylaws, a business owner is risking not being provided limited liability protection if it is sued.

5.  Bylaws Help Avert Misunderstandings Among Owners.

Communication and clear expectations are key to any successful relationship, including the relationship between business owners.  Bylaws clearly lay out how the company will be run, which can be crucial in preventing misunderstandings over how the owners expect the company to be managed.

6.  You May Need Bylaws to Setup a Bank Account, to get Loans and Insurance.

Finally, if you would like to open a business account or apply for loans generally banks will require you to provide a copy of your bylaws.  In addition, insurance companies may require you to provide a copy of your company’s bylaws before providing certain types of polices.

As a business owner it is often tempting to cut corners to lower costs. A strategically thought out set of bylaws should not be one of these cut corners.   Instead, bylaws should be recognized for what they are – one of the wisest investments a business owner can make to ensure the long-term effectiveness of their company.

Connect with Doug via Twitter or at bendlawoffice.com. Did you enjoy this article? If so, subscribe to YFS Magazine and never miss an update. Don’t forget to make our friendship official and join Young, Fabulous & Self-Employed entrepreneurs on Facebook.

Disclaimer: This post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  YFS Magazine expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post.

Photo Credit: © Viorel Sima