STARTING A NEW COMPANY – Do It Right ! – A Corporation

 

1. ENTITY BASICS: A Corporation is a legal entity that that is established to do business. A corporation is established so that the corporation is an entity that has a legal existence separate from its owners (the “shareholders”). If a Corporation is properly formed, the shareholder’s separate personal assets are not subject to the corporation’s creditors, including judgment creditors, except to the extent that the shareholders have agreed to be personally liable, such as by signing a personal guarantee, by signing an agreement or note as a co-obligor, or by providing personally owned assets as security. Here are some key definitions:

1.1 Shareholders. The owners of a corporation are called “shareholders or “stockholders” because their interests are usually represented by stock certificates representing a number of shares in the corporation. Different types of stock can be issued with different rights relative to voting rights, participation in dividends, and participation in the proceeds of any sale of the company’s assets upon liquidation.

1.2 Directors and Officers The shareholders elect one or more directors who direct the affairs of the corporation. The directors elect the corporation’s officers, such as President, Vice-President, Secretary and Treasurer. The directors are the policy makers, and the officers are employed by the corporation to put the directors’ policies into effect.

(a) In large corporations, the board of directors may select a “Chairman of the Board,” and the board may be subdivided into committees with specific authority. It is also common to have “executive committee” that has authority to make certain decisions without approval by the full board of directors.

(b) In addition to the traditional corporate officers, there can be other officers,

including chief executive officer (CEO), chief operating officer(COO), and

1.3 Multiple Roles. In most states, a corporation only needs one shareholder,

one director, and one person acting in the roles of several officers. In a large corporation, the chairman of the board may be the CEO, or the chairman of the

executive committee may be the CFO.

2. Formation: A corporation’s formation is governed by state law. If a corporation

formed in one state wishes to do business in another, it must qualify to do business

in that other state according to the laws of that state.

2.1 Articles of Incorporation. A corporation is formed by filing “Articles of Incorporation” with the Secretary of State. The Articles are usually brief, containing only the most basic information about the corporation that is being formed. The Articles set forth the name of the corporation, location of the principal office, the name of the agent for service process, the number of shares of stock, and the names of the initial officers and directors, etc. The Articles of Incorporation are simple, but they are only a part of the corporate formalities that must be followed in order to be entitled to the benefits of corporate status.

(a) Resident Agent. The corporation must appoint to serve as the “resident

agent” or “agent for service of process.” This is a person or business in the state of corporation that agrees to be served with papers in the event of a lawsuit. This agent must accept that position in writing, and that written acceptance must be filed with that Articles of Incorporation.

(b) “60-Day List. Within sixty days of the filing of the Articles of Incorporation, an officer of the corporation must sign a list containing the names and mailing addresses for all officers and directors of the corporation.

2.2 Bylaws. The bylaws outline the government of the corporation. The bylaws

specify the duties and responsibilities of the corporations shareholders, directors

and officers. While the Articles of Incorporation are usually very brief, the

bylaws are usually much more detailed, including information regarding

meetings and the corporation’s technical operations. Sometimes the Articles

will contain provisions that may be modified by the bylaws, but the general rule

is that a provision in the Articles of Incorporation will take precedence over a

contrary provision in the bylaws.

2.3 Organizational Meetings Once the corporation has been legally formed by

filing the Articles of Incorporation, the corporation must be sign organized. The

directors named in the Articles must meet to authorize the issuance of stock,

elect officers, and adopt the bylaws. The directors may also want to approve a

corporate seal, authorize the opening of one or more banks accounts, and make

other decision relating to the start up of the business or its transition into

corporate form.

2.4 Stock Issuance. Stock certificates should be issued to each stockholder. Each

person receiving stock must pay for the stock, but the payment can be in almost

any form, including promissory notice and services. Anyone receiving stock for

services must report the value of the stock as taxable compensation on his or her

income tax return.

3. Maintenance: A corporation requires maintenance. If it is not properly maintained, it may be ignored. If you need assistance with any of this, please contact us or another qualified professional.

3.1 Financial Records. A business’ most important records are its financial

records. Corporate accounting records should be kept current, and all

tax returns should be filed. The corporation’s financial records must be

maintained separate from those of any director, officer, or shareholder.

The corporation must have a separate tax identification number, which should be used for all corporate transactions and tax returns. Corporate assets, including bank accounts, investments, real property, and vehicles should be titled in the name of the corporation where appropriate.[1] If a shareholder or employee of the company uses corporate assets for personal use, he or she must either pay rent or recognize taxable income (in accordance with acceptable business accounting practices and in accordance with applicable tax laws). Once the corporation is formed and officially recognized, no one should pay ever pay a corporate obligation with a personal check and no one should pay a personal obligation with a corporate check.

3.2 Meetings. The shareholders and directors should meet as often as necessary to

hold elections and make decisions, not less than once a year. It is common to have the shareholders’ and directors’ meetings together or on the same day, and

for closely held businesses where the shareholders and directors are the same people, the meeting of the shareholders and directors can be a joint meeting.

(a) Minutes of the meetings are kept to record the decisions that are made,

usually documented in the form of “resolutions” that are adopted pursuant

to parliamentary procedure.

(b) In the most states, the law permits resolutions to be adopted in the absence of a formal meeting if a “consent resolution” is signed.

(1) As for decisions made by the board of directors, the consent resolution

must be signed by all directors. This is sometimes referred to as a

“unanimous consent resolution.”

(2) As to decisions made by the shareholders, the consent resolution must

be signed by the number of shareholders that would have been required

if a meting had been held and all eligible to vote had attended.

(c) We recommend that at least once a year the shareholders elect the directors

and the directors elect the officers. Of course, the officers and directors can

be elected for more than a one- year term, the election of various directors

and officers can be staggered so that all are not elected during any one election. These elections may be done at a meeting or by consent resolution (as discussed in paragraph 3.2 (b), above).

3.3 Business Licenses. You must comply with all applicable local ordinances in the

operation of the corporation’s business. Obtain and maintain all required business

licenses. Contact city, country, and/or state agencies to make sure that you have

been licensed by all appropriate authorities.

3.4 Trade Names, Trade Marks, Copyrights, and Patents. You cannot operate a

business using a name of a company or product that is the same or “deceptively

similar” to the name already in use by another individual or business. Similarly, you

cannot conduct business in violation of applicable copyright and patent law. You

are responsible to make sure you are not infringing on the rights of others, and you

may need to take steps to discourage others from violating your rights, and to do

this, it may be advisable to engage a patent and trademark attorney.

3.5 Employees. You must follow federal, state, and local laws relating to employment,

payroll taxes, worker’s compensation insurance, occupational safety, and all other

laws and regulations relating to employees.

4. P ROTECTING AGAINST LIABILITY: As stated above, a corporation’s

obligations.

4.1 The “Alter Ego” Rule. A corporation will be ignored by the courts if it is deemed to be nothing than the “alter ego” of its shareholders.

(a) The “alter ego” argument is used by company creditors (whether businesses or individuals) who are owed money by the corporation that the corporation itself is unable to pay. Such creditors want the corporation to be ignored so that they can seek payment from the corporation’s owners, and they can be successful in having the corporation disregarded as a legal entity if the corporate formalities are not observed,if personal and corporate assets are commingled, if personal obligations are paid for out of the company funds, if company assets are used for personal use without payment or without being treated as part of an employee’s compensation, and/or if corporate financial records are not properly kept.

(b) The “alter ego” will not be applied to a corporation that keeps accurate records of its meeting of directors and shareholders, that keeps its financial

affair completely separate from those of its shareholders, that has its financial records maintained or at least reviewed by a certified public accountant, and that makes sure that all business is conducted in the corporate name.

4.2 Co-Obligor vs. Guarantor. For new corporations without a solid net worth and an established business track record, it is common for a company creditor (referring to anyone who extends credit to the corporation) to require a share holder whose financial resources are substantial to either be a guarantor or co-obligor with the corporation.

(a) A “guarantor” is one who has agreed to meet the corporation’s obligations if the corporation is unable to do so. Traditionally, a guarantor could not be

held responsible for a guaranteed obligation unless and until the creditor had exhausted its remedies against the primary obligor, the corporation.

(b) A corporation’s creditor may consider the enforcement of a guarantee unnecessarily burdensome, and so it is common for the creditor to insist that the shareholder be a “co-obligor” with the corporation. It is not common to see the world “co-obligor” in a written agreement, but it is common to see a provision that makes the corporation and the shareholder “jointly and severally liable.” Such a provision allows the creditor to sue either the corporation or the shareholders or both, and the shareholder could be required to pay the entire obligation if the corporation to do so.

(c) Of course, there are arrangements that amount to a cross between a guarantee and a joint obligation, requiring the creditor to make some attempt to collect the obligation from the corporation first, but not requiring the creditor to exhaust all remedies before turning to the shareholders.

(d) So, while a corporation exists to eliminate a shareholder’s personal liability for corporate obligations, a shareholder can negate the protection by signing an agreement that makes the shareholder a guarantor or co-obligor.

5. CONCLUSION: If you are going to establish a corporation, please do it right. This will involve the observance of proper legal formalities, and it requires the advice of

qualified financial advisors.

5.1 Business Formalities. A corporation should not conduct business as a corporation until it has been properly formed under state law. This means, at a minimum, that the Articles of Incorporation must be accepted by the Secretary of State, that the shareholders have met to elect the board of directors and adopt bylaws, and the directors have met to select officers and adopt resolution regarding the operation of the company’s business

5.2 Financial Affairs. The most important advisor for a corporation is its accountant. Making sure that financial records are properly kept and tax returns are timely filed will go long way to preserve the corporation’s good standing and continued legal existence. Of course, if investments are to be maintained, an investment advisor should also be consulted.

5.3 Legal Matters. Business operations rely on compliance with the law, and the firm’s attorney can assist in discovering what laws apply and how to comply with those laws. In addition, it is a rare business that will not be involved in negotiating, signing, and complying with legally binding contracts. Sometimes it can be penny wise and pound-foolish for company officers and directors who are not attorneys to act without advice of legal counsel. Similarly, a shareholder who is asked to sign an agreement as a guarantor or co-obligor should not do so without the advice of independent legal counsel.

 

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[1] If corporate investment assets such as real estate, equipment or investments are considerable, it is recommended that such assets are titled to a separate Limited Liability Company (“LLC”) or Limited Partnership. The LLC or partnership may then lease the assets back to your corporation.