Governance as a Risk Management Tool
Choosing the most appropriate business entity for a farmers market can be a simple risk management tool that rewards the owners or directors with personal liability protection. It also can motivate strong business procedures that create consistency and predictability in decision-making processes. Each of these is important when it comes to preventing problems and controlling the damage when problems inevitably occur. This section on governance as a risk management tool is specifically about how to best take advantage of the farmers market’s structural choice, whatever it may be, to manage risk. The section on Governance overall compares and contrasts the various structural choices available to a farmers market.What kind of risks does Governance help manage?
What is Governance?
When this toolkit refers to governance, it means two closely related things: (1) the business entity (nonprofit, corporation, etc.) of the farmers market and (2) the documents that control how that business entity operates. Both are important. As discussed here, forming a business entity that offers liability protection is good, but it’s not necessarily enough. Any business entity should also create strong governance documents (bylaws, for example) if it wants to rely on that protection. The title of the market’s governance document(s) will vary depending on the business entity utilized.
|Business Entity Type
|Name of Governance Document
|Bylaws and Shareholder Agreement
Organizing documents for for-profit businesses generally address the following issues:
- What is everyone contributing to the business, financially?
- How does the business make big decisions? For example, if the business takes on debt, does everyone have to agree? Just a majority? Does one person have the ability to make that decision?
- What does the business do with profits or losses? Are they split down ownership lines?
- What if someone decides to leave the business? How will that ownership be bought out? When?
- Is there a process for bringing new owners into the business?
Organizing documents for nonprofit organizations focus on how boards of directors are elected or appointed plus their terms, responsibilities, and other structural matters. Cooperative business bylaws have more issues to deal with in terms of equity payments, dividends, and other financial matters.
Using Governance as a Risk Management Tool
Risk management through choosing a governance entity
Farmers market business owners and nonprofit directors can protect their personal assets from the farmers market’s liabilities by choosing to organize as something other than a sole proprietorship or partnership. LLCs, corporations, and other options all provide personal asset protection from liability, as discussed here (LLCs), here (corporations), and here (nonprofit corporations). Although not nearly as important as insurance, forming a business entity with liability protection is a good second line of defense. This line of defense is most likely to hold up in court when it is supported by strong governance documents.
Risk management through clear governance documents
Using clear governance documents is a solid risk management tool for any market. Even a market that chooses to organize as a partnership (for example, because they don’t want the costs of an LLC) is better able to manage risk when the partnership has a clear partnership agreement. Organizing documents clarify how the business operates on a fundamental level: how people get into the business/organization, how people get out, how the business/organization makes decisions on things such as debt, and many other very important processes. When these processes are clearly stated upfront, the business or organization avoids legal disagreements down the road and is more prepared to meet its legal obligations. Although governing documents play a less important role where the market has just one owner/decision-maker (because the decision-making process is straightforward), farmers markets that have more than one owner, an advisory board, a board of directors, officers, and/or any other team of decision makers will greatly benefit from clarity in the organization’s decision-making processes.
- An LLC may have a member-manager who is charged with making certain decisions on behalf of the business. The types of decisions this person can make is an issue that strong governance documents can resolve in advance.
- A partnership may allocate responsibility for tax matters or accounting details to a specific partner. The person appointed to these responsibilities and the nature of their duties are a matter of governance.
- A nonprofit board of directors may take nominations and hold elections for new board members. How nominations are received and when elections are held, as well as who votes in the elections, are all issues of governance.
- In a sole proprietorship, the owner of a business may state that they hold responsibility for all decisions, which is also a clarification of the business's governance.
From a legal perspective, solid governing documents protect the business or organization by creating consistency and predictability, assuming the documents are followed. Consistency and predictability are important from a legal perspective because they establish the legal legitimacy of an action. When a person is authorized to take an action (such as getting a bank loan or buying a vehicle), and then they act accordingly (receive the bank loan on the authorized terms or buy the authorized vehicle), then the court and other stakeholders know that the business is responsible for the action. By the same token, if a person is not authorized to take an action, the court and other stakeholders can refer to the organizing document to prove the action was not authorized.
Why is it important that everyone know that the business is responsible for actions like loans and purchases? If the loan was an act of the business, then it’s a business liability. As readers of the Business Structure section know, an LLC, corporation, and nonprofit shield the assets of individual owners from business liabilities. They do not shield the assets of individual owners from personal liabilities—owners/directors are still on the hook for their personal actions, of course. Thus, it needs to be clear whether an action is in the name of the farmers market or of the person who performed it. Further, as stated in the Insurance section, business insurance covers the actions of the business. If it’s unclear whether an action was one of the farmers market or of the individual, it’s then unknown if there’s insurance for damages that might occur.
When a business or organization does not have rules controlling who is responsible for what or how board members are elected, the court can’t determine who had control of the situation. This can make it more difficult for the farmers market to defend itself in court. For example, if a farmers market is facing a lawsuit related to a debt, but can’t show who chose to take on the debt or how the decision was made, the market will have a hard time proving that the decision was made in a business capacity.
Writing Clear Governance Documents
Talk first, draft later
Writing clear governance documents begins with a thorough discussion by all owners, partners, members, or directors about a variety of governance issues. Ideally, the stakeholders will come to an agreement about how they want the farmers market to be governed. Then those decisions are drafted into a formal document. Many markets will choose to have this document reviewed by an attorney to make sure it’s internally consistent, doesn’t violate any laws, and is legally enforceable. After the document is finalized, all parties generally approve it in a formal action. That’s it! Governance documents aren’t filed with the state or a court, unless a legal action occurs. (The exception is the documents that actually create an LLC, corporation, or cooperative: articles of organization and articles of incorporation. These documents are filed with the state as part of the process of creating the entity. These documents outline just a few basics, such as the registered agent and official location of the entity.
Going forward, many businesses and organizations choose to review their governance documents on a regular basis. This serves two purposes: First, it reminds stakeholders of the governance procedures, making it more likely that they will be followed. Second, it gives the market a chance to assess whether the governance document still reflects their wishes. Governance documents can generally be changed at any time by the approval of all stakeholders.
For much more detailed information on writing solid partnership agreements, operating agreements, and bylaws, see the resource titled Farmer’s Guide to Business Entities, available as a free download from Farm Commons at www.farmcommons.org. This guide contains very detailed information on governance documents for each kind of business entity. It has checklists to assist stakeholders in identifying important issues. It also contains model operating agreements and bylaws to assist people in creating their own. Although it is written specifically for farmers rather than farmers markets, the material is relatable to both.
To understand more about each business form and how they compare to each other generally, visit the Business Structure section of this Toolkit.