Basics of Business Formation: Internal Governing Documents

Once you have selected the right business entity for your business in Alabama, the next crucial step is to prepare internal documents governing the business entity. Each business entity should have internal documents that define ownership, management, and operational rules. Having the right internal documents in place not only promotes smooth operations but also helps avoid future disputes, ensures compliance with applicable law, and protects an individual’s legal and financial interests. Below is a high-level summary of the key internal documents typically required for each type of business entity.

1. Sole Proprietorship

A “sole proprietorship” is “a business in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity.”[1] Because the entity is operated by one individual and doesn’t require formal organizational documents to exist, it does not need internal documents to define its ownership, management, and operational rules.

2. General Partnership

In Alabama, general partnerships are automatically governed by Alabama’s Partnership Law unless the partners create their own written partnership agreement.[2] An Alabama general partnership may create a “written partnership agreement” that “governs the relations among the partners as partners and between the partners and the partnership.”[3] In other words, if there’s no written agreement, the partnership must follow the default rules set out in Alabama law.

A partnership agreement should cover things like:

• Ownership percentages and capital contributions[4]
• Profit and loss distributions[5]
• Partner authority, power, and agency[6]
• Procedures for adding[7] or removing partners[8]
• Dissolution and winding up[9]

One of the key points of having a partnership agreement is that it can limit or eliminate any responsibility for breaking a contract or duty — including fiduciary duties — owed by a partner or anyone else to the partnership, another partner, or anyone else covered by the partnership agreement.[10] Having a partnership agreement is important because it allows the partners to decide their own rules instead of relying on default state laws.

3. Limited Liability Company (LLC)

An LLC offers the flexibility of a partnership combined with the liability protection of a corporation. Although filing Articles of Organization creates an Alabama LLC, internal documents are crucial to clarify how the LLC operates. Alabama LLCs are governed solely by the Alabama Limited Liability Company Law, unless there is a written “limited liability company agreement” (also called an “operating agreement”).[11] The “limited liability company agreement governs relations among the members as members and between the members and the limited liability company.”[12]

A limited liability company agreement (or operating agreement) should address:

• Management structure – either “member-managed” or “manager-managed”[13]
• Ownership structure and contributions[14]
• Profit and loss distributions[15]
• Member authority and voting rights[16]
• Procedures for adding[17] or removing[18] members
• Dispute resolution and dissolution terms[19]

One advantage of a limited liability company agreement is that it can limit or completely remove a member’s (or another person’s) responsibility for breaking a contract or duty owed to the LLC, another member, or anyone else who is part of or bound by the LLC agreement.[20] Having an operating agreement is one of the most important steps in forming an LLC, it allows the members to decide their own rules instead of relying on state defaults.

4. Corporation (C-Corp and S-Corp)

Corporations are more formal structures that must follow specific legal rules, known as corporate governance requirements, when creating the corporation’s internal documents.[21] After incorporation a corporation’s board of directors must adopt initial bylaws for the corporation.[22] The corporation may also include shareholder terms in the bylaws or create a separate shareholder agreement to outline those details.

A corporation’s bylaws should address:

• Stock – authorized stock, issuance of stock, distributions to shareholders[23]
• Shareholders – rights, meetings, and voting[24]
• Board of Directors – powers, election process, qualifications, removal, meetings[25]
• Committees (if any)
• Officers – positions, appointment process, qualifications, specific officer roles and responsibilities[26]
• Indemnification[27]
• Records and maintenance of records[28]
• Dissolution[29]

A shareholder agreement may address:

• Management of the shareholders
• Fiscal matters such as cash/capital calls
• Buy-sell provisions for stock
• Distributions to shareholders
• Indemnification

A corporation’s internal documents not only define the rights and responsibilities of directors, officers, and shareholders, but also help prevent future disputes and ensure compliance with applicable laws. Establishing clear governance and operational procedures from the outset lays a solid foundation for the corporation’s long-term success and legal stability.

5. Limited Partnership (LP)

A LP is a formal business structure that must meet certain legal requirements to maintain its status. One key requirement is creating and adopting a partnership agreement, which serves as the roadmap for how the LP operates.[30]

A partnership agreement should address:

• Limited Partners – admission, powers, and liability[31]
• General Partners – admission, powers, liability, and management rights[32]
• Contributions to partnership[33]
• Distributions to partners[34]
• Dissociation of partners[35]
• Dissolution and winding up[36]

Like with LLCs and general partnerships, an LP’s partnership agreement can limit or completely remove a partner’s (or another person’s) liability for breaching a contract or duty owed to the LP, another partner, or anyone else who is part of or bound by the partnership agreement.[37]

6. Nonprofit Corporation

A nonprofit corporation in Alabama is governed by the Alabama Nonprofit Corporation Law.[38] Under the Alabama Nonprofit Corporation Law, a nonprofit corporation must create and adopt bylaws.[39] The bylaws must include certain provisions to comply with both state and federal requirements.

The bylaws of a nonprofit corporation should include:

• A detailed description of the nonprofit corporation’s purpose[40]
• Whether or not the nonprofit corporation will have members[41]
• Members (if the nonprofit has them) – admission requirements, powers, meetings, voting rights, resignation and termination.[42]
• Board of Directors – powers, election process, qualifications, removal, meetings.
• Committees (if any)[43]
• Officers – positions, appointment process, qualifications, specific officer roles and responsibilities[44]
• Conflict of interest provision/policy[45]
• Disposition of assets and approval requirements[46]
• Dissolution[47]

Having properly drafted organizational documents is especially important for a nonprofit because they are essential for qualifying for and maintaining IRS tax-exempt status under Section 501(c)(3) or other relevant provisions.[48] Clear bylaws help ensure compliance with both state and federal laws and provide a strong foundation for the organization’s operations.

Final Thoughts

Every type of business – whether a general partnership, LLC, corporation, limited partnership, or nonprofit – has its own internal document requirements. The purpose, however, is the same: to provide clarity, ensure legal compliance, and protect the people involved. Properly drafted internal documents help prevent disputes, define roles and responsibilities, and create a solid foundation for long-term success.

In our next post, we’ll walk through what an Employer Identification Number (EIN) is and how you can get one for your business.

Need help preparing or reviewing your company’s internal documents? Contact our firm for personalized guidance and legal support.