The LLC Operating Agreement

The LLC Operating Agreement is a key document for a business organized as a New York Limited Liability Company, especially if that business has more than one owner (the owners are “Members” in LLC terminology). If an LLC business was like a marriage, the LLC Operating Agreement would be like a prenup, parenting agreement and divorce settlement all in one.

Why you should have an LLC Operating Agreement

While the New York limited liability company law provides for some default rules applicable to LLC businesses that do not have an LLC operating agreement in place, the members of the business are well advised to craft their own rules by way of an LLC Operating Agreement (which is actually required by law in New York, Section 417).  The members of the LLC business are given great flexibility to regulate their rights and responsibilities with respect to the LLC, management of the LLC and pretty much everything else that concerns the LLC and the LLC Members. Only very few rules in the NY LLC law cannot be modified by an Operating Agreement.

The LLC Operating Agreement sets forth the rules that apply to the members of the LLC and the management of the LLC.   It should give answers to the following questions:

  • Who owns what of the LLC business?
  • Who contributes what to the business of the LLC?
  • Who gets how much of the business profits of the LLC?
  • When are LLC business profits to be distributed?
  • How are the members to manage the day to day affairs of the LLC business?
  • Are there specially appointed Managers to manage the LLC business, rather than management by the LLC members?
  • Who can vote on non day to day, monumental business decisions affecting the LLC business?
  • Who has which responsibilities regarding the business of the LLC?
  • What other obligations do the LLC members have to the business and to the other LLC members?
  • What happens if an LLC member wants to leave the LLC Business or sell his or her membership interest?
  • How can new LLC members join the club?
  • Should the LLC members be allowed to force someone to leave the LLC Business?
  • How can the LLC be dissolved?
  • What happens upon dissolution of the LLC and how are the assets to be distributed?

All these and more are questions to be addressed in an LLC Operating Agreement.  Ideally, you should hire a business attorney who specializes in startup matters and LLC operating agreements to draft your LLC operating agreement.  However, an educated client is the best client and knowledge of the key issues in an LLC Operating Agreement is key for efficient cooperation with a business attorney.

Management Provisions in an LLC Operating Agreement

Management provisions in the LLC Operating Agreement deal with the management of the LLC business, which basically means decision making for the LLC business. There are ordinary business decisions (think: buying copy paper at Staples, landing another customer, paying employees….) and extraordinary business decisions, such as obtaining financing for the LLC business, selling major equipment, taking in a new owner, i.e. a new LLC member, merging with another business, and so forth.

Default NY LLC law Rules: Management by Members

As per NY LLC Law, by default, the LLC is managed by its Members (Section 401) and each Member has authority to make ordinary business decision for the LLC and bind the LLC (i.e. enter into contracts in the name of the LLC) in connection with such ordinary type decisions. Extraordinary business decisions, however, require a formal authorization by the LLC Members (Section 412). The formal authorization can be by majority vote of the LLC Members in a meeting or by written consent.

Management by Managers

If you set forth in the LLC’s Articles of Organization (the document that was filed with the Secretary of State in Albany in connection with the formation of the LLC), that the LLC shall be managed by Managers, New York law has a second set of default rules applicable to the management of the LLC. In that case, the Manager(s) have the authority to make ordinary business decision for the LLC and bind the LLC (i.e. enter into contracts in the name of the LLC) in connection with such ordinary type decisions. Extraordinary business d ecisions require a formal authorization by the Manager(s). If there is more than one Manager, a majority vote or written consent constitutes such formal authorization.  In that case, the LLC Members do not have any authorization to manage the day to day business affairs of the Company.

However, some extraordinary business decisions still require the consent by the LLC Members. The law has a list of such extraordinary events (admit a person as a Member, dissolve the LLC, and so forth, look in Section 402 (c) and (d)).

Drafting your own Rules

When you read the NY LLC law, it almost always states “except as provided in the Operating Agreement…). This is your ticket to draft your own rules with respect to the management of your LLC.

Here are common matters written into LLC Operating Agreements with respect to the management of the LLC business:

No required Annual Meetings

By default, under NY LLC Law, meetings of LLC Members must be held annually. In order to keep administration of the LLC lean and mean, many LLC founders decide to NOT require annual meetings of the LLC members and state as much in the LLC Operating Agreement.

Board of Managers

LLCs with many Members or Members who are not involved in the day-to-day management of the LLC can provide for a Board of Managers, similar to the structure in corporations.

LLCs can establish committees with responsibilities designated by the Board of Managers, Officers with special titles, such as President, Vice President and others.

In that context, you can provide how many people should be on the Board of Managers and who are the initial persons to serve on the Board of Managers.

You can provide for special veto rights by certain people, how Managers are to be elected, how they should be replaced or fired, if necessary.

In LLCs with only a few involved LLC Members and no Managers, you would also set forth who of the Members has authority to decide about day-to-day LLC business decisions and bind the LLC in contracts and agreements.  You could also provide for certain areas of responsibilities assigned to each managing LLC Member, like Joe is responsible for the LLC’s marketing and Jack for sales and distribution of the LLC.

Retained Voting Rights of LLC Members

You can set forth a list of LLC business decisions that are so important to your LLC that they always require a vote by the LLC Members, despite management of the LLC by Managers or a few select Members.  In that respect, you would also provide the level of consent that is required (majority, super majority, or unanimous consent) for such decisions.

Voting Requirements

How many votes does each LLC Member or Manager have when it comes time to take a vote? The default rule for member managed LLCs under NY LLC Law: The Members vote in proportion to each Member’s share of profits.  Example: Joe gave $10,000 as startup capital to the LLC and Jack gave $90,000.  Joe gets 10% of all the profits of the LLC and Jack gets 90%.  Joe gets 10% of the votes and Jack gets 90%, i.e. in matters requiring majority consent, Jack would always have the last word.

You can change voting requirements for the LLC in numerous ways.  There can be special groups of LLC Members who have voting rights different from other LLC Members and independent of their economic interest in the Company.  There can even be LLC Members who have no voting rights at all.

Ownership, Contributions and Distributions of Profit in an LLC Operating Agreement

The LLC Operating Agreement will have provisions stating what the LLC members have contributed upon formation of the LLC.  Contributions can be in the form of money, property or services.  While not a contribution per se, the Operating Agreement can also provide that the LLC members may have the right to grant loans to the LLC.

Read more about Capital Contributions in Funding the Company.

The LLC Operating Agreement further has to address the economic ownership rights of its LLC members.  (Economic ownership rights are usually distinguished from the voting and management rights of the LLC members.)

There is equity ownership in the LLC which represents the LLC member’s right to share in what is left over of the company upon its dissolution or if it were to be sold as a whole to another person or entity.

Then there is the right to receive distributions of the LLC’s profits as it goes along and makes money.  LLC members have a right to receive their share of profits, i.e. money left over from the revenues of the LLC’s business after expenses.

In the most common scenario, LLC members share equity ownership and profit distribution rights equally.  For example, if A and B each own 50% of the LLC and nothing else is stated in the Operating Agreement, A and B would each have a right to 50% of the equity ownership and the profit distribution rights.

But it is the beauty of the LLC, that the Operating Agreement can provide otherwise.  For example, if A contributed $50,000 to the starting capital of the LLC and B nothing, they could agree that they both own 50% of the equity ownership of the LLC, but that A will initially receive ALL the profit distributions of the LLC until he has received back his initial capital investment.

LLC Member Obligations in an LLC Operating Agreement

These days, LLCs are often founded around a brilliant idea which requires a lot of development, creation and “sweat equity.”  As a consequence, it is a good idea to include certain obligations of the LLC members in the LLC Operating Agreement.

Confidentiality

Each member should be obliged to keep all LLC business confidential.

Non- Competition

Members should be restricted from competing with the business of the LLC or soliciting employees, vendors or customers away from the LLC to another business venture.  Note though, that restrictive covenants like non compete provisions and non solicitation provisions have to be reasonable to be enforceable in court.

Intellectual Property

If the LLC members are creating intellectual property on behalf of the LLC (software, designs, innovative methods of doing anything), the LLC Operating Agreement must set forth that all such intellectual property has to be immediately assigned to the LLC and is not and will not be the property of the individual LLC members.

Participation in the LLC Business

The LLC Operating Agreement could  set forth that certain members have distinct responsibilities with respect to the operation of the LLC.  For example, it could provide that A is responsible for research and development and B for sales and marketing.  If the agreement was silent, you could potentially have the situation that A works 24 hours a day to make things happen and B sits around and does nothing.  Without obligations in the LLC Operating Agreement, A could do nothing about B’s inactivity.

Buy Sell Provisions in an LLC Operating Agreement

While many LLC Operating Agreements are silent on this point, it is a good idea to include so called Buy Sell provisions in the LLC Operating Agreement.

Buy Sell provisions set forth what is going to happen when an LLC Member wants to leave the LLC, dies, is unable to continue his or here duties, declares bankruptcy,  wants to sell his or her interest to an outsider, or when the LLC members are hopelessly deadlocked in the management of the LLC.  All of these scenarios could seriously harm the LLC or the remaining members.

The most common buy sell provision is probably the so called right of first refusal, which would provide that an owner can sell his LLC membership interest to an outsider if he or she has first offered it to the LLC or the remaining LLC members and such members declined.

Then there could be provisions forcing a buy out of an LLC member if such member has committed a serious breach of his obligations against the LLC.  Or, in case of a professional LLC, if any member has lost his license to practice the profession of the LLC.In each buy-out situation it is important to have terms that provide the exact mechanism of a sale and exit of an LLC member as well as the method of determining a price for the LLC membership interest.
It is also common to limit the price being paid for an LLC membership interest under certain circumstances.  For example, if a member decides to leave before the expiration of a certain period after formation of the company, he may not be able to get much if anything for his interest, since he or she hasn’t put in enough effort to have earned it.

Doing Business As

D.B.A. or “Doing Business As” is not only a cool bar in the East Village, it also refers to individuals (sole proprietorships), partnerships, corporations and other entities that do  business under a name different from their real name.  For example, Joe Smith operates a computer service business under the name “Computer Geeks to the Rescue,” (fictional example) and Town Sports International, LLC operates a popular gym under the name “New York Sports Club” (real life example.)

If you are starting a business, but don’t want to form a legal entity yet (corporation or LLC), a business certificate gives you the ability to call your business something other than your personal name.

When you do business under a name different from your real name, you have to file a business certificate either with the county clerk of your county or with the Secretary of State in Albany.     Here are the rules:

Read more

If you have ever started a business, you know what it is like to wake up in the middle of the night and be worried sick.  Being in business exposes you to a lot of risk.  The key is to plan for risk and minimize it where possible, so that you can find the sleep you need to succeed.

Here are the ten most common strategies to minimize risk when operating a business:

1.  Forming a Business Entity

The right business entity can shield your personal assets from creditors of the business.

The right business entity can also shield business assets from personal creditors of the owners of the business.

2. Removing Assets from the Business Entity

Since business assets are exposed to attack by creditors of the business, it is wise to remove as many assets as possible from the business entity, or not even put business assets into the entity in the first place.  A combination of business entities, a regular withdrawal of business assets, and a smart funding of business entities with owner loans and liens can minimize the risk that important business assets are open to attack by creditors.

3. Hiring Independent Contractors instead of Employees

Employees can get business owners into trouble.  Some of the liability issues are avoided by outsourcing business tasks to independent contractors.

4. Entering into Founder Agreements with your fellow Business Partners

Properly drafted founder agreements, such as shareholder agreements, operating agreements or partnership agreements can prevent sticky situations with co-owners and provide clear rules with respect to forced buyouts of owners, exist strategies for owners, vesting of owner equity and so forth.

5. Keeping your Books and Records in Order/Complying with Formalities

Co-mingling personal assets with business assets, neglecting to hold and document required corporate meetings, neglecting to properly document transfers of assets in and out of the business can be the death of any properly structured limited liability shield and asset protection strategy.  Creditors who can show neglect in such respects may be able to pierce the corporate veil of the limited liability entity and reach your personal and business assets.

6. Solid Business Contracts

Business Contracts that properly spell out the deal you want, provide for dispute resolution mechanisms and identify the proper parties can prevent many misunderstandings and hassle with your customers and suppliers.

7. Using the Law to your Advantage

Getting proper protection for your intellectual property to the full extent of the law can prevent theft and infringement of such property by third parties.

8.  Complying with the Law when raising Money

Being aware of and following state and federal securities laws and regulations when raising money can keep you out of serious (even criminal) trouble.

9. Assembling the Right Team to Look out for your Business

To paraphrase Seth Godin in How to Succeed in Business to Business, you need people who will be consistently on time, on budget and most importantly, people who don’t cause you to lose sleep.  That your lawyers, accountants and other advisers are brilliant at what they do, should be a given.

10.  Getting Insurance

Despite the best business entity structure, adviser teams and other strategies, there remain risks that can be insured.  Even limited liability business entities have many
exceptions to the limited liability shield.  A good business insurance broker can tell you about the risks that can be insured.

**This post is for informational purposes only and does not constitute legal advice**

As many of you undoubtedly know, after filing for a New York LLC, you have to fulfill the expensive and wholly unnecessary publication requirement. This means you have to arrange for a notice of the formation in two New York newspapers for six weeks each.  People have tried fighting this requirement in court and lost.  It is still alive and well.  I wrote more about how to actually effect the publication here.

Consequences of Failure to Publish LLC

So you may wonder, what happens if I don’t file the newspaper ads? Is the only issue that I lose the ability to do business in NY?

Yes, if you fail to publish and file the certificate of publication in the required time frame (120 days after formation), the LLC’s authority to carry on, conduct, or transact business in New York will be automatically suspended (see Section 206(a) of the New York Limited Liability Company law).  That sounds scary, but what does it actually mean?

What does suspension mean in practical terms?

It is unclear.  The law was amended in June of 2006 and the part about “carry on, conduct, or transact business” is new.  Would have been a nice gesture by the law makers to leave us some pointers, but no such luck.

At minimum, this follows from failure to publish:

The LLC will not be able to sue in New York State courts (Federal courts in New York don’t seem to care one way or the other), but can still be sued.   But even when non-published LLCs sue, New York courts have allowed them to fulfill the publication requirement and then continue with the law suit.  No harm done.  There is one case where a complaint by an “unpublished” LLC was actually dismissed: Small Step Day Care, LLC v. Broadway Brunswick Builders.

In order to find out whether an LLC is published or not, one has to order a good standing certificate from the Department of State.  You won’t find that information on the online business entity search page.

Failure to Publish does not destroy liability shield of LLC or its ability to actually do business

But, you can be sure of the following:

The members (owners) of the LLC will still be protected by the limited liability shield of the LLC.

Any contract between the LLC and any other party does not become invalid, because the LLC failed to publish.  You can still technically carry on business.

Can I “cure” the failure to publish at a later point in time (when I saved up enough money)?

Once the LLC  takes care of the publication requirement, the law provides that the LLC regains its authority to “carry on, conduct, or transact business in New York.”  The suspension is considered “annulled”.

According to New York Civil Practice Law and Rules section 3016(b), in a fraud cause of action in a complaint, “the circumstances constituting the wrong shall be stated in detail”.  Contrast this with the standard for a libel or slander pleading in 3016(a): ” the particular words complained of shall be set forth in the complaint”. Lawyers might be excused for thinking that there was a slightly less exacting standard for fraud than defamation.

In a 2014 decision, the Appellate Division First Department was very specific about specificity, dismissing a fraud claim “because the words used by defendants and the date of the alleged false representations are not set forth”, Gregor v. Rossi, 120 A.D.3d 447 (1st Dept. 2014). The Court in effect closed the gap between fraud and defamation pleadings, requiring that even a fraud pleading name the speaker of a misrepresentation and quote the words used. Trial courts in the First Department, which covers Manhattan and the Bronx, have since applied the new rule to dismiss fraud claims. In Board of Mgrs. of 141 Fifth Ave. Condominium v 141 Acquisition Assoc. LLC, 2015 N.Y. Misc. LEXIS 3775 (Supreme Court New York County 2015) the court held that “the amended complaint does not set forth a specific statement and, often, does not identify a specific document in which these statements allegedly occurred. Such allegations are insufficient to state a fraud claim”. In Davoli v Dourdas, 2015 N.Y. Misc. LEXIS 1345 (Supreme Court New York County 2015) the court stated that “The particularity requirement of CPLR 3016(b) requires, in general, that the complaint specify the language of the alleged misstatements and the time and place that were made”.

Experienced defense practitioners are used to seeing fraud claims included as afterthoughts in what are essentially law suits for breach of contract. By raising the bar on specificity, the Appellate Division has acted to discourage this practice, and to require plaintiffs not to make allegations of fraud unless they really have facts to back it up.

An unpleasant but common experience: an old judgment against you comes back to haunt you. Possibly you didn’t even know it existed: the complaint may have been served in the wrong place and you never got a copy, or the opposing party may even have filed a false affidavit claiming you were served (known as “sewer service”).

The first way many of us find out that an old judgment (from as long as twenty years ago) is still out there is when we are notified by our bank that a restraining notice has been served and funds are frozen. A collection law firm, usually a specialist, has taken on the mission of finding you and making your life difficult. Restraining notices are issued by the lawyer, no judge’s signature needed, and are often shot-gunned out to every bank in town until one finds you.

An unpleasant new wrinkle from the last few years is that if a bank with branches in New York received a restraining notice in New York based on a New York judgment, it would restrain your account with that bank even in another state.   I think this development was caused by a widespread misunderstanding of a decision by New York’s highest judicial body, the Court of Appeals, which had not intended to authorize this behavior (Koehler v. Bank of Bermuda Ltd., 12 N.Y.3d 533). Recently, the Court of Appeals in a new case (Motorola Credit Corp. v Standard Chartered Bank, 2014 NY Slip Op 07199 (2014)) issued a clarification that New York restraining notices do not affect banks in other states. It seems as if some national banks haven’t yet heard the news, though.

A restraining notice on your bank account is harmful and distressing, but it can be challenged. If you were never served with the original complaint (and, in certain circumstances, even if you were) it may be possible to vacate or reopen the judgment, and make the restraining notice go away. These claims can often be settled, sometimes for pennies on the dollar. Finally, the banks themselves are required to send you a notice explaining that there are circumstances under which you can seek an exemption, for example if the frozen funds were social security (which is untouchable) or your salary in a pay roll account (they can only freeze ten percent).

The first question for every small business owner who decided to form an entity?  LLC or S corp?  Which one is better for me?

Let’s face it, most people would chose the entity that leaves more money in their pocket.  So let’s compare the tax costs and startup costs of these two entities.  This assumes that the business owner is the sole owner of the business.

As a brief recap, an s corporation is a corporation that elected to be taxed as an s corporation.  When you form a corporation, you are a shareholder and the corporation can distribute income to you by way of a salary or profit distributions, aka dividends.  Most importantly, a corporation offers protection from personal liability for debts of the corporation.

A limited liability company offers the same protection from personal liability.  As a member of an LLC, all the profit goes to you directly, you are not paying yourself a salary.

Cost of forming the Entity

LLCScorp
 Articles of Organization: 200 Incorporation: 125
 Expedited Handling 24 hrs: 25 Expedited Handling 24 hrs: 25
 Certified Copy: 10 Certified Copy: 10
 Publication in Albany:  350 Tax on 200 shares: 10
Total:       585Total:         170

 

So it is cheaper to form the s corporation, which is mainly due to the archaic LLC publication requirement, which serves no real purpose other than to put money into the hands of newspapers (I guess they need it) .  And, unfortunately, usually the cost of publication is higher than in Albany County…in New York County it is more like $1200.

Tax Consequences of LLC v. Scorp

What about the tax situation?  Does one entity cause less tax liability than the other?   This is a highly fact specific question and depends on all your sources of income.  But my friend and esteemed CPA Jonathan Medows did an experiment and compared the 2013 tax situation of two small business owners making $75,000 in revenue and each having $15,000 of business expenses.  He came to the conclusion that it didn’t matter much whether they operated their business as an LLC or an S corp.  Each had about the same personal and business tax expenses (LLC: $20,476,  S corp: $20,755).  Please see here for his article on the subject.

So should you run to form the s corporation?  Personally, I would not go with the s corp.  The upkeep of the s corp requires more paperwork and ongoing tax filing responsibilities, because you have to treat yourself as a formal employee of the corporation.

Klick here to Let us form your LLC!

LLCs without an Operating Agreement

Many if not most small business limited liability companies with two or more members do not have an operating agreement.  An operating agreement is the document for an LLC that provides for rules and provisions regarding the management of the LLC and the members’ rights vis a vis the other members and the LLC.   It is highly advisable to have an operating agreement, especially if you are a minority member of an LLC.  But what rules apply to an LLC without an Operating Agreement?

Let’s look at what happens when you do not have an operating agreement.  Maybe that will teach you to invest the money into having a proper operating agreement drawn up.

Default New York LLC Rules

LLCs without an operating agreement are primarily governed by the New York limited liability company law.

Under this law, the following rules would apply to an LLC and its members:

(Let’s assume the LLC has 3 members, Joe, Jane and Jessy)

Entering into Contracts

Either one of Joe, Jane and Jessy can enter into (most) contracts for the LLC and legally bind the LLC without asking the other two members  §401(a) of the LLC Law.  For example, Joe could sign a lease in the name of the LLC and not involve Jane and Jessy in that decision.

Voting and Distribution

Each member’s voting rights and rights to distribution of the LLC profits would be determined on the basis of the value of their contributions to the LLC as stated in the LLC’s records §402(a) LLC Law§ 504.  Assuming again that Joe, Jane and Jessy probably also didn’t keep records of the value of their respective contributions, one would have to determine the value of each member’s contribution.  How much value can you put on that web design contributed by Joe compared to  the cash pumped into the LLC by Jane and Jessy?  This can get messy and a breeding ground for conflict.

But let’s assume it was relatively straight forward and each of Joe, Jane and Jessy contributed $1000 to the LLC.   This would mean that each of Joe, Jane and Jessy have equal voting rights, but any two of them could outvote the other.  Similarly, each of Joe, Jane and Jessy are entitled to equal amounts of distributions from the LLC.

Continuing with the above assumptions,  Joe and Jane could decide to outvote Jessy and welcome Betty as a new member in the LLC without the consent of Jessy  § 402(c)(1).

Joe and Jane could dissolve the LLC without the consent of Jessy § 402(d)(1).

Joe and Jane could decide to sell all of the assets of the LLC without the consent of Jessy § 402(d)(2).

Joe, Jane or Jessy could decide to assign their membership in the LLC to a complete stranger.   § 603(a)(1)  However, the complete stranger would not have any rights to participate in the management and affairs in the LLC, meaning he can’t vote.  But he/she would be entitled to receive distributions from the LLC as the old member would have received.

Joe, Jane or Jessy cannot withdraw from the LLC prior to the dissolution of the LLC   § 606(a).

Adoption of Operating Agreement

Joe and Jane could decide to enter into a binding operating agreement for the LLC without the consent of Jessy. 402(c)(3)

No Expulsion of Members

Now, even with a majority vote, neither member can be involuntarily expelled from the LLC, no matter how egregious the behavior.  Nevertheless, Joe and Jane could adopt an operating agreement without the consent of Jessy and that operating agreement could contain provisions providing for the expulsion of a member for misbehavior.

If the operating agreement of your New York limited liability company is silent on the subject, there is no law in New York that allows you to expel another member, no matter what he or she did to you or the business.  You are stuck with that member.

Thus it may make sense to adopt an operating agreement that has provisions about member expulsion.

In case a member behaves really badly, the LLC can make that member leave, possibly forcing him to accept a buyout, on terms relative to the wrong he or she committed.

Great care is necessary in drafting these provisions.  If misbehavior is drafted too broadly, everybody will walk on eggshells in order to avoid expulsion or a group of members may conspire against another member to make him/her inadvertently break the rules.

First, what are the grounds for expelling someone?  Some of the options are: Failure to provide the services they promised; loss of professional license necessary to be a member of the LLC, such as in a professional LLC; a serious breach of confidentiality or other material rules of the operating agreement.  And so forth….

Second, there has to be a provision that states when the expulsion is triggered: A Vote of the members? What majority is required?  Is the member who is being accused of wrongdoing excluded from voting?

Third, what are the consequences of an expulsion?  The member could be excluded from voting and just remain with an economic interest, which means he/she receives distributions but cannot participate in the management of the business; He/she could be forced to sell his/her full interest, but on what terms and what is the valuation procedure?

 

You’ve got homework to do before you can successfully sell your small business.  Even if you already have an interested buyer, attention to the details at this stage of the game will help you in the long run and protect you from unexpected snafus.  Your small business lawyer should be able to help you with these steps.

1.   If you’re leasing space for your business, find out from the landlord of the premises (and check your lease) what he/she requires in order to consent to an assignment of your lease to the buyer.  Usually the Landlord wants to see that the proposed buyer is credit worthy and has a good chance to continue your business successfully and consequently be able to pay his rent;

2.   Make sure you have a copy of your lease and all its extensions and modifications.  Check the requirements in the lease regarding the assignment of the lease to a buyer of the business.  If you’re lucky the lease “only” states “any assignment of this lease requires the consent of the Landlord, which consent may not be unreasonably withheld.”  This tells you that your landlord has to give your proposed buyer serious consideration.

3.   If you’re not of the super organized type, do a lien search on your business (the business owners) and its assets in order to find out if there are any forgotten liens outstanding.  You may have forgotten about some age old tax lien, equipment lien and so forth.  If you find liens, pay them off or disclose them to the buyer and arrange for pay off letters with the creditors.  Pay off letters provide for the payoff of debts at closing and guarantee the buyer that the creditor will release you, the seller, upon payment of the debt.  If the payoff occurs at the closing, the funds could come from the proceeds of the selling price.  Neglecting to disclose outstanding debts could make you liable for a breach of the representations and warranties in your sales agreement.

4.   Make a list of all relationships with vendors, service providers, large customers.   To the extent you have ongoing contracts with any vendors, service providers or customers, assemble all those contracts.  Read (or have your small business lawyer review) all these contracts to determine what happens to them in the case of a sale of the business.

5.   Make a list of all assets of the business and determine their initial cost and depreciation status (or have your accountant do it).  Have you accountant or small business lawyer advise you on the tax consequences of a sale of the business and how to best allocate any purchase price to various asset groups.  Get your financial statements in order and ready to be presented to the prospective buyer.

6.   Clean up your business, literally.   A little staging and polishing goes a long way to increase your selling prospects;

7.  If you have staff, determine all your operation procedures and manuals and other ways of doing business smoothly and day to day.  The more you can show that your business is not that dependent on you, the prior owner, the better it is for a prospective buyer of your business.  A “turn-key” business is what you’re going for.

8.  Get all your permits and licenses together and in order, determine if the licenses are assignable or if the new buyer has to get new licenses and permits;

9.   Get emotionally ready to let your business go!  Not sure what that would entail for you, but I think an overly attached business owner doesn’t make a good business seller.

 

 

It is rare that a business in New York owns the property from which it operates.  Most businesses rent commercial space for their store/restaurant/warehouse or other venture.  Thus, the owners of the business will be party to a lease with the owner of the building that houses the business.  This lease becomes an important piece in the puzzle that is the process of selling/buying a business in New York.

When it comes to selling or buying a business that has a lease, the lease becomes an important part of the selling/buying process.  The buyer should carefully check the lease terms to not only determine the rent and the remaining term of the lease, but also whether the lease can be assigned.  What does that mean?  If the buyer wants to buy the business, the buyer should be able to step almost entirely into the shoes of the prior business owner, including the right to occupy the business premises.  In order to do that, the buyer has to take over the existing lease for the premises or make sure that the landlord of the premises is willing to give him/her a new lease.  If the buyer plans to take over the existing lease, he/she has to make sure that the current lease allows an assignment of the lease to a buyer of the business or if not, that he/she gets the approval of the landlord to take over the lease.

Leases vary greatly in what they state regarding the assignability of the lease.  Some state “this lease can not be assigned without the express consent of the landlord” or “this lease can not be assigned without the express consent of the landlord, which consent may not be unreasonably withheld.”  Others may spell out specific requirements for a potential new tenant before a landlord even considers an assignment of the lease.  There may be additional security deposit requirements or even fees for the landlord for allowing another tenant to take over the lease.

In most cases it becomes necessary for the buyer to prepare an application and submit it to the landlord.  With the application, the landlord will determine whether the proposed buyer is creditworthy and has the financial resources to carry on the business and pay the rent on the lease.  If the lease does not have the aforementioned clause “which approval may not be unreasonably withheld”, the landlord has wide discretion to turn down the buyer and thereby cancel the deal.  No buyer would want to buy a business without having the approval of the landlord to take over the lease.