BUSINESS FORMATION & RESTRUCTURE

BUSINESS FORMATION AND RESTRUCTURE

Corporations are separate legal entities that are typically used to operate a business. Corporations give the advantage of limited liability meaning that we risk only the amount we invest in the company, provided that we properly operate the corporation. Corporations are not complicated to set up but we do have to follow some important steps and create a number of documents. We have here an overview of the key elements in creating a corporation.

Preliminary Corporate Foundation Issues

Forming a corporation requires us to take some basic steps. Corporations are subject to state statutes, and the rules and procedures for creating corporations vary from state to state. Make sure that you consult your states laws for the precise rules.

Naming the Corporation

Companys name is a serious decision that impacts our ability to create the documents necessary to properly form the corporation. Not only does the name we choose affect our customers image of oour company, but the uniqueness of our name can also affect future trademarks, service marks, and our ability to conduct business in our own state and in other states.

Before we decide on a name for our corporation we need to do these searches:

  • Has another company filed a conflicting trademark or service mark with the U.S. Patent and Trademark Office?
  • Is our proposed name available in key states in which we intend to do business? A conflict in another state generally prevents the company from qualifying to do business in that state under that corporate name.
  • Can we get the desired domain name?
Have Several Names in Mind

Unfortunately, many names are already taken, so be prepared to check the availability of several names at once. Also, remember that the state corporation statute typically requires that the corporation’s name include the word Corporation, Company, Inc. or Incorporated. Similarly, many laws prohibit the use of certain words, such as Bank or Insurance in the corporate name unless the corporation qualifies as such entity.

After a Name Is Cleared

After we receive a clearance on a name, we can either incorporate right away with the name or reserve it for a while by filing for Name Reservation.

Choosing a State of Incorporation

Laws that affect corporations vary from state to state, we have to incorporate under the laws of the state in which the corporation intends to conduct its principal business. Most states have pamphlets on how to incorporate, with sample forms that we can get from the Secretary of States website.

Creating the Articles of Incorporation

After we select the corporate name and state of incorporation, we must file the official document creating the corporation with the Secretary of State. This can be filed by any corporate lawyer or on one of the online incorporation services. This document is called the Articles of Incorporation or the Certificate of Incorporation, depending on the state. The Articles of Incorporation are typically short two to three pages long. The key sections are as follows:

Corporate Name: This section of the Articles identifies the formal name of the corporation.

Purpose of Corporation: Many states allow this section to simply state that the purpose of the corporation is to engage in any lawful activity for which the corporation may be organized in that state.

Duration: Most state statutes provide that the corporation can have a perpetual duration.

Authorized Capital: This section must set forth the total number of shares that the corporation can issue, the per value share, and the different classes of stock. This section should authorize a sufficient number of shares to cover the founder is shares plus shares that may be issued to future employees or investors. If the state doesn it charge extra, think about authorizing 10,000,000 or more shares.

Name and Address of Registered Agent: Most states require the corporation to designate the name and address of a registered agent for service of process in the state. The registered agent is the person given notice of lawsuits filed against the company. If the incorporation is in a state other than where the principal office is, we can designate various professional registered agent companies for a fee.

Other required provisions: Depending on the state law, some provisions, such as preemptive right to purchase future shares, must also be contained in the Articles to be effective.

Classes of Stock

We can provide many classes of securities to investors in exchange for the capital that they make available. Two of the most common securities are common stock and preferred stock.

Common Stock:

Shares in the corporation that have no preferences or priorities over other classes of stock. The rights to distributions, number of votes per share, liquidation rights, and other rights are typically the same for all shareholders on a share-by-share basis.

Preferred Stock:

Shares that give the holders various benefits over the common stock holders. Many professional investors, including venture capitalists, favor preferred stock over common stock. Preferred stock often has the following rights:

  • Priority on the business is assets upon liquidation
  • Priority on any dividends
  • Special voting or veto rights
  • Right to force the company to buy back the shares at some point in the future
  • Protection against certain stock splits, stock dividends, and future cheap issuances of stock
  • Possible separate right to elect a designated number of directors
  • Issuing Stock and Securities Laws

In issuing shares to its initial shareholders, the corporation must ensure that it complies with both state and federal securities laws. These laws apply whenever we offer or sell a security, such as common or preferred stock.

Keeping a Stock Ledger

The company must keep good records of stock issuances, showing the amount of stock issued, dates issued, and funds received. A Stock Ledger can help the company organize this information.

Action of Incorporator

Incorporator is the person who initially organizes the corporation. The incorporator uses a document called an Action of Incorporator to perform important functions such as adopting bylaws, electing directors and signing the Articles of Incorporation. The incorporator can be a lawyer, a prospective shareholder, or another interested individual. Make sure that the document is dated or effective on or after the date of incorporation, and insert the document in the corporation is minute book.

Owners and Operators of the Corporation

The shareholders of the corporation are the owners of the corporation, the investors who receive ownership in the corporation in return for money or assets they invest. The shareholders elect a Board of Directors, who have overall responsibility for the business of the corporation. The Board, in turn, elects the officers of the corporation (CEO, vice president, secretary, and chief financial officer, typically). The officers handle the day-to-day affairs of the corporation.

The Board of Directors

The directors must act in connection with the best interests of the corporation and its shareholders. Board members can provide valuable wisdom and experience in guiding a company to success. Board members maintain a fiduciary relationship with the company. The size of the Board is up to the discretion of the shareholders and should meet on a regular basis. After filing the incorporation papers with the Secretary of State, the Board needs to adopt organizational resolutions that concern preliminary matters for properly establishing the corporation.

Initial Actions by the Board of Directors

The Board of Directors can accomplish the organizational resolutions of the corporation by adopting them in a meeting that they call in accordance with the corporations bylaws or by unanimous written consent. Generally, the directors authorize the following:

  • Issuing securities and granting warrants, options, or other rights to purchase securities
  • Adopting a stock option plan
  • Amending the Articles of Incorporation or bylaws
  • Entering into major contracts, leases, or other obligations
  • Declaring distributions, dividends, or stock splits
  • Borrowing significant sums and providing security for loans
  • Entering into Employment Agreements with key employees
  • Electing officers of the company and setting or changing their compensation and terms of employment
  • Adopting or amending employee benefit plans
  • Calling shareholders meetings
  • Buying or selling significant assets
  • Adopting company policies
Shareholders

Founders of the business typically buy stock in the company and are the first shareholders. Later on, investors can contribute money or other assets and also become shareholders. A corporation is required to hold annual meetings of shareholders, the principal purpose of which is to elect the members of the board of directors. Some of the actions for which shareholder approval may be required or desirable include the following:

  • Merger or reorganization of the corporation
  • Amendment to the Articles of Incorporation
  • Amendment of the bylaws
  • Sale or transfer of all or substantially all the corporation is assets
  • Approval of contracts with interested directors
  • Issuance of certain securities
  • Adoption of stock option plans
  • Dissolution or winding up of the corporation
Bylaws

The bylaws of a corporation contain the rules and procedures that govern the rights and powers of shareholders, directors, and officers. The bylaws are typically adopted by the incorporator or by the board of directors in the organizational meeting, or with written consent in place of the organizational meeting. The bylaws cover the following:

  • The size of the Board of Directors
  • When and how board meetings are called
  • When and how shareholder meetings are called
  • Duties and responsibilities of directors and officers
  • Procedures for exercising voting rights
  • Regulation of the transfer of corporate stock
  • The company�s fiscal year
  • General corporate matters
Buy-Sell Agreement

Buy-Sell Agreement provides for the buying and selling of the stock in a corporation of a withdrawing shareholder. This agreement can benefit both the corporation and its owners. A shareholder may either want to withdraw from the corporation for a number of reasons, including the following:

  • Wanting to sell
  • Death, disability, or expulsion from the business
  • Termination of employment
  • Bankruptcy
  • Retirement

Setting the price of the interest to be bought and sold is both the most important and most difficult part of the Buy-Sell Agreement. Valuing a closely held business is fraught with potential difficulties, but it is a critical part of the agreement. Key provisions of the Buy-Sell Agreement include the following:

  • Restrictions on transfer of shares
  • Permitted transfers
  • Mandatory repurchase in certain cases
  • Optional repurchase by the company or by the shareholders
  • Obligation of transferee
  • Possible purchase on death, total disability, or termination of employment
  • Valuation
  • Dissolution of corporation
  • Termination of agreement
  • Spouse/partner is consent

This agreement can be extremely complicated and is very important for maintaining the continuity of the company.

Right of First Refusal Agreement

Shareholders of startup companies often enter into a Right of First Refusal Agreement requiring shareholders to give the company or the shareholders the priority right to match any offers to buy shares in the company. This right arises when a shareholder wishes to sell his or her stock. Key provisions of the Right of First Refusal Agreement include the following:

  • Restrictions on transfer
  • Right of first refusal
  • Legend on a stock certificate
  • No transfer to competitors
  • Term of agreement
  • Will provisions
  • Spouse/partner is consent

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