You think have a valid corporation or a limited liability company (also called an “LLC”) because you have filed with the State. But do you have a valid business entity? Most business owners organize their business as a corporation or LLC to add a layer of creditor protection. With a properly organized corporation or LLC, you can protect yourself from many business creditors in the event the business fails or gets sued.
When starting up a new business, you may be tempted to organize it on your own without the aid of an appropriate professional legal advisor. However, if you do not properly organize and/or do not act like a corporation or LLC, the protection that you thought was there, is not.
Most new business owners do not know that it takes more than just filing Articles of Incorporation or Articles of Organization with the State to properly set up a corporation or LLC. The filing of the Articles is only the first step in setting up your business.
Firstly, there are provisions that are not in the State printed forms. 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.
For example, with a corporation, you can put in additional creditor protection provisions to add additional layer of protection for your directors. With an LLC, you can designate whether the LLC is member managed or manager managed.
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 in 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 properly.
It is not uncommon for new business owners to file with the State and never issue any documents granting ownership interests. Corporations need shareholders and LLCs need members.
If your corporation or LLC never issues any evidence of ownership, it has no owners. And if your company has no owners, who owns the business? It could be determined that you are operating the business as a sole proprietor. As a sole proprietor you have unlimited personal liability for all business debts and lawsuits. You could lose your house, savings accounts and other assets in the event of a catastrophic business creditor.
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 co-owner, 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 co-owner? 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.
If there is more than one owner, you should also have a comprehensive buy-sell agreement for when one owner leaves the company through death, disability, retirement or any other reason such as the owners just cannot get along. Without a comprehensive buy-sell agreement, you may end up in court when a co-owner leaves. This could result in tens of thousands of dollars in legal fees. It’s like the old Fram oil filter commercial, “Pay me now, or pay me a lot more later.”
Setting up a business on your own is kind of like wiring a house. You can go to Home Depot, get the instruction books, buy your materials and wire it yourself. But there is always going to be a risk of electrocution or a fire. Similarly, with a corporation you can attempt to do it yourself, but if you do not follow all the rules and the laws, your risk is unlimited liability for business debts and lawsuits.
Properly set up your business using professional legal advisors who are familiar with corporate and LLC laws and also individual and business taxation matters. The choice in selecting which entity that you use, be it a corporation, an S corporation or an LLC, is determined by your particular business and tax situation. If your business attorney is not familiar with taxation matters, have your business attorney consult with your tax advisor to determine which type of entity is the best for you.
I have heard people say they can’t afford the eight hundred or one thousand dollars that it would cost to pay an attorney to properly set up a corporation or LLC. One of the most common reasons that small businesses fail is because they are under-capitalized. If you can not afford the eight hundred or one thousand dollars to pay an attorney to properly set up your corporation, you might want to rethink starting your business right now. You probably are under-capitalized and would be unable to fund a start-up business. Protect yourself, protect your family, protect your assets by properly organizing your business.
By: Matthew M. Wallace, CPS, JD
Published edited February 28, 2010 in The Times Herald newspaper, Port Huron, Michigan as: Ensure your startup corporation is properly organized