When starting up a new business, you may be tempted to set it up on your own without the aid of an appropriate professional advisor. You may think that all you have to do to set up a corporation or a limited liability company (also called an LLC) would be to fill out the online form of Articles of Incorporation or Articles of Organization and file them with the State.
If that is the case, what you and many other people don’t realize is that the filing of the Articles is only the first step in setting up your business. There are many other documents and steps that need to be completed in order to set up your business properly as a corporation or LLC.
If you don’t properly set up your business from the onset, you may not be able to take advantage of the limited liability protections of a corporation or LLC. You must act like a corporation or LLC, or you run the risk that you have personal liability for company debts.
For example, if you did not put LLC or Inc. or Corp. on your business cards and invoices, your customers may think that they are dealing with you directly as a sole proprietor. If you are acting like a sole proprietor and do not hold yourself out as a corporation or LLC, you could have unlimited liability for company debts regardless of the corporate or LLC form.
If you just fill in the blanks in the online forms, you may be missing out on some additional provisions to limit your liability or aid in the management of your company. On many occasions, I have even seen company organizational documents attempted to be prepared by non-attorney professional advisors such as tax preparers or accountants. These advisors apparently think that all you need to do is fill is some blanks on forms obtained online or from an office supply store. In over 20 years of my practice, I have never seen non-attorney prepared business organizational documents completed correctly.
When setting up a corporation, you should have a complete and comprehensive set of bylaws that set forth management structure and govern the operation of the corporation. You must have organizational meetings in which the incorporators authorize the issuance of the stock. The stock must be issued to stockholders who have their initial meeting to begin operations and elect directors of the corporation. The directors also must have an organizational meeting to implement the business plan and elect the officers which usually consist of a President, Vice President, Secretary and a Treasurer, who manage the day-to-day operations of the corporation.
With an LLC, the organizers must meet to determine the issuance of membership interests. Then the members must meet to enter into a comprehensive operating agreement which governs the management of the LLC and to elect managers, if any.
Once you have setup as a corporation or an LLC, you must keep up with annual formalities of the organization or risk personal liability for company debts. There are annual filings that must be kept up. Often overlooked with corporations is the requirement of annual shareholder and director meetings.
If you have a partner, you may want to set up your business 50/50, so each owner has an equal say in the business. This is all well and good, but what if you cannot agree on a decision with your partner. In that instance, you are stuck with inaction and may deadlock all decisions of the company. Your only recourse may be court proceedings.
When setting up a company with two owners, I recommend that you put some sort of deadlock protection in your bylaws or operating agreement. You could add a minority owner who owns 5% or 10% of the company who would be the swing vote to create a majority. You could also set it up with one owner having 49% and the other with 51%, so that if there is a disagreement, the owner with 51% rules. Another alternative is for the owners to appoint an independent third party to be the tie breaker in the event of an owner deadlock.
One thing to keep in mind when setting up a corporation or LLC is that it is a lot more than just filing a form with the State, or grabbing a company record book from an office supply store and filling in the blanks. It is necessary to have an experienced business attorney to prepare your organizational documents to make sure they are set up properly and in order to get the maximum amount of liability protection.
By: Matthew M. Wallace, CPA JD
Published edited April 12, 2009 in The Times Herald newspaper, Port Huron, Michigan as: Don’t cut corners starting a business