Startups, Get Your Corporate Act Together!
If you spend the time and expense to incorporate your small business, then you should make sure you observe the corporate formalities. There are many reasons for observing corporate formalities. The most important reason is that if you don’t, you are leaving yourself open to someone trying to “pierce the corporate veil”—getting at your personal assets for the liabilities of the corporation. This blog describes corporate formalities for a small business.
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Structuring the startup business as a corporation
Starting a new business is challenging. New businesses are generally structured as corporations or limited liability companies (LLC). After consulting with their small business lawyers, most founders will select a LLC structure because there are fewer corporate formalities and more flexibility with a LLC than a corporation.
There are still good reasons to form your business as a corporation. For example, if you want to attract investment and your investors will put their money only into a C corp, then your choice is easy: C corp, even if that means that you may be giving up some flexibility that the LLC form offers.
Related article: Forming a New Business: Corporations vs LLCs
When you start your business, you have a dizzying list of things to do to set up your business. We have given you a checklist for starting your business.
Related article: Checklist for Starting a Business
Now you need to get your corporate records in order. For LLCs, this is a lot easier, which is why the majority of founders form LLCs rather than corporations. But if your sole investor requires a C corporation, then you are stuck. This article discusses the major actions for startups formed as corporations.
Articles of incorporation are public information
As part of the formation process, your startup lawyer has prepared articles of incorporation or, in some states, certificates of incorporation. The articles can be perfunctory or more extensive. Sometimes you may want to address some or all of the following issues in the articles, especially for corporations that are on a high growth trajectory:
• indemnification of officers, directors or other employees
• limiting the powers of the corporation, directors and stockholders
• granting stockholders preemptive rights
• duration of the corporation
• setting the required number of votes for actions by stockholders and directors
You will see that the articles are signed by an incorporator, which may or may not be someone connected with the company. At many law firms, a paralegal or legal assistant may sign the articles as the incorporator.
The other main issue is the authorized capital of the startup company. If the company will have more than one class of stock, then the articles need to reflect how many shares for each class and the par value of the shares of each class of stock.
For companies that imagine going public, the standard number of authorized shares is 10 million, but there is no magic to this number. If the corporation will remain closely-held then you may want to consider authorizing fewer shares. And in some states, you may have to pay franchise taxes based on the number of authorized shares.
Statement of incorporator
The incorporator, the person who signs the articles of incorporation, can be anybody, a paralegal, a lawyer, even the custodian. Then in the normal course, the incorporator transfers power to the board of directors. This is usually done by way of a statement of the incorporator. This document is usually a one-page document.
In the statement of incorporator, the incorporator elects the board of directors, which is the key element of this document. In some cases, the incorporator may also adopt the bylaws, although sometimes this is left to the first meeting of the board of directors. This statement is a key link to the corporate formation process. Unfaithful incorporators sometimes happen.
First meeting of board of directors
Once the corporation has a board of directors, it can start operating. If it is a small business, the founder may be the only member of the board.
The first order of business is for the board of directors to pass numerous resolutions regarding the operations of the company. Although the corporation may have a meeting of directors, usually the first meeting is memorialized in a consent. All of the directors sign the consent to pass the resolutions.
Some of the most important initial resolutions that the board will pass include adoption of the bylaws of the corporation, issuance of stock and election of officers.
Bylaws not filed
The bylaws of the corporation are govern the conduct of the business, providing the operating policies and procedures of the company. The bylaws enumerate the powers and responsibilities of the directors and officers. They lay out the procedures for calling a shareholders’ and directors’ meetings.
The bylaws detail voting procedures and the percentage of votes required to adopt certain actions. The bylaws usually provide for indemnification of directors, officers and employees. And most importantly, they specify how the bylaws may be amended.
The bylaws may contain other provisions that are not in conflict with the articles of incorporation. If there is a conflict between the articles and the bylaws, the articles prevail.
Other corporate actions for startups
Once the startup business has completed these initial corporate tasks and adopted the necessary resolutions to commence operations, it is almost ready to commence operations.
The company needs to obtain a federal tax identification number also known as the employer identification number (EIN). The bank will require the EIN and a corporate resolution for the corporation to open its bank account.
The company’s startup lawyer will ensure that a corporate minute book and stock ledger are created. The lawyer may also assist the founders in establishing a capitalization table. And the shareholders may enter into a shareholders’ agreement that enumerates the rights and responsibilities of shareholders and may include provisions on representation on the board or restrictions on transfer of shares.
Maintaining corporate records
After this flash of activity at the founding of the business, it is incumbent on the company to maintain the corporate records. Properly maintaining the corporate records, sometimes referred to as corporate housekeeping, is essential to comply with corporations codes.
Properly maintenance of the corporate records include holding annual shareholders’ meetings, memorializing resolutions adopted by the board in the minute book and issuing shares of stock. These may seem mundane but corporate housekeeping is critical if you are to maintain the corporation separate from its shareholders.