When forming a business, the first step is deciding what type of entity is best (for example, a corporation, partnership, or limited liability company). The best entity form depends on structure, liability, tax, and management considerations. For a basic list and general ideas about what entity might be right for you, check out the 4 Basic Business Entities for your Startup for additional discussion.
This article deals specifically with corporations, and the documents you need before starting your corporation business venture. In general, corporations are a common form for companies that:
- Have a formal management structure.
- Are currently or will become a public company.
- Have owners (stockholders) or managers who desire:
- a predictable and recognized legal structure;
- limited liability; and
- perpetual existence.
When deciding to incorporate, there are a number of threshold issues to consider. The following is a list of key documents you should have drafted to help govern your corporation. These should be in place and ready to go before forming the corporation.
The following are the steps required to form and organize a corporation.
Draft Formation Documents
Although the certificate of incorporation is the only document required to be filed in many states, there are several other documents needed to properly form and organize a corporation. Check with a local attorney familiar with your particular state for the actual filing requirements. The first step is to obtain the necessary information (such as the name of director(s) and registered agent(s)) before drafting these documents. If the corporation is being formed in connection with a transaction, consider the availability of signatories when selecting directors and officers. The following documents are used to form and organize a corporation.
Certificate of Incorporation
The certificate of incorporation is the primary governance document of the corporation and is filed with the state of formation. Once stock is issued, the substance of the certificate of incorporation can only be amended with stockholder consent. Depending on your state, you should consider whether there are any additional provisions to include in the Certificate of Incorporation, such as indemnification of directors and officers. If the corporation has multiple classes of stock or will be a public company, the certificate of incorporation will be a longer and more complicated document.
By-laws set forth the governance rules of a corporation, but are secondary to the certificate of incorporation. If there is any conflict between the certificate of incorporation and the by-laws, the certificate of incorporation governs. Typical areas covered by the by-laws include the procedures for the meetings of stockholders and directors (including record date, notice, and voting), the officers, and committees of the corporation and the issuance and transfer of stock certificates. Usually the board of directors can amend the by-laws although that power often needs to be authorized in the certificate of incorporation.
Organizational Action of the Incorporator and First Meeting of the Board of Directors
Immediately after the certificate of incorporation is filed, the incorporator (or initial directors if named in the certificate of incorporation) takes action to adopt the by-laws, appoint directors, and transact other limited business that is authorized under state law. Once the directors are appointed, it is customary to hold an initial meeting either in person or by written consent to transact further organizational business such as electing officers, opening bank accounts, issuing stock, and approving the corporate seal. In some states, like Delaware, the law allows a corporation to appoint its initial board of directors in the certificate of incorporation. In that case, the organizational action of the incorporator is replaced by the first meeting or unanimous written consent. Other states will require the passing of Organizational Minutes of the Board to authorize and formalize the first actions of the corporation. Again, check with a lawyer who is familiar with your state for the specifics.
Issuance of Stock
The corporation issues stock to its stockholders after, or at, the first meeting, or with unanimous written consent of the board of directors. Typically each stockholder enters into a subscription agreement setting out payment and any other agreed terms for the issuance of the stock to him or her. In some instances, depending on whether the stock offering was made publically or privately, such as a representation might include a warranty that the stockholder is an accredited investor. If the corporation actually issues stock certificates, you must draft a stock certificate and deliver it to the shareholder. A form of stock certificate is often provided in the minute book, but it can be ordered or downloaded from a variety of sources. A stock certificate must be signed in original by two officers (typically the president and secretary). All issuances of stock should be recorded in the stock ledger.
Issuances of stock must comply with federal and state securities laws. Consider whether there are any registration or notification requirements under the applicable securities laws. If there are only a few stockholders, the issuance typically qualifies for an exemption to registration under the federal securities laws. If stock is being widely offered, counsel must determine if the stockholders are accredited investors or fit within other exemptions. The issuance of stock is also regulated at the state level by each state’s securities laws (commonly referred to as blue sky laws). It will be necessary for your counsel to review the securities statutes and regulations of each state in which the stock will be offered or sold and comply with all applicable filing and fee requirements. Make sure you speak with an attorney who is familiar with the various securities laws applicable to your situation.
Although not required, stockholders sometimes enter into agreements with each other at the time of formation to set forth certain rights and obligations, such as voting, transfer restrictions, and registration rights. These terms may be addressed in one stockholder agreement or in several shorter agreements. Think of the Stockholder Agreement as the “prenuptial agreement” between the various shareholders. Remember, the terms of the Shareholder Agreement will dictate the basis you can sell or dispose of your stock in a corporation. The Stockholder Agreement provides the greatest amount of protection not only to the corporation, but also the shareholder. Don’t skimp on this one.
Organizing your corporation shouldn’t be rushed. Take the time to really think about what you want in place and how you want certain events to take place over time. There are many boilerplate agreements out there, and while they may do the proverbial trick, they might also create more problems down the line. The key here is to consult with a lawyer who will really be able to understand the direction you want to take with the business and help you craft a solution that will take your goals and objectives into consideration. Take the time to strategize and look to the future because if you run into any problems, they won’t be today, they’ll be several tomorrows away.
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