by LawInc Staff
February 19, 2014
In an attempt to save money, many new business owners avoid using an incorporation attorney and choose to either incorporate on their own or use an unqualified document filing service. Unfortunately, they realize the consequences of their cost saving measures once its too late.
For that reason, it is best to work with either a business formation specialist or an attorney who specializes in business formation to ensure everything is done correctly. An improperly formed and maintained corporation will jeopardize both the corporation itself and its shareholders in case of a lawsuit or dispute.
Before deciding whether or not to hire an incorporation attorney to help with forming your new business, considering the following common mishaps that startups encounter when not using a professional.
Failing to Select the Proper Type of Entity
So many important questions must be asked when starting a new business specifically pertaining to which entity type, corporation or LLC, is right for your startup. You should be very careful about soliciting or receiving advice from a person who is not properly trained in the field of business law.
It’s extremely important that you discuss critical questions about to your business with a trained professional. This is specifically important when one wrong decision could result in financial disaster in case of a lawsuit.
Some of many questions that should be asked when deciding to incorporate or form an LLC are: Which entity provides the most tax savings? Is there anything I need to do protect myself and the business since my co-owner is having marital problems and may file for divorce after our business is formed? Which entity is best for me if I want to contribute services, instead of cash, in exchange for stock. Can I form an S corporation if my business partner is not a US citizen? I heard incorporating will not fully protect my business name, should I also register a trademark? Am I allowed to form an LLC if I am a doctor? Should I also purchase insurance for my corporation if I incorporate? What type of legal entity should we create if we are planning on seeking venture capital after the first year of business.
Failing to Plan for Contingencies
Many startups are short sighted at the incorporation stage and they fail to account for problematic circumstances that could arise in the future. Important contingencies to consider include, divorce, death and incapacity of co-owners. Corporations with more than one shareholder should always prepare and execute buy-sell agreements to dictate what steps are taken in such situations. Non-attorney incorporation services do not offer these agreements and cannot give advice regarding whether or not you’ll need them.
Failing to Properly Draft Articles of Incorporation
Many states allow additional language to be added to the Articles of Incorporation which help limit the liability of the directors for monetary damages. Language that indemnifies the directors and officers to the fullest extent permissible under law may also be added.
If do not choose to use an incorporation attorney and opt to use a document filing service or do it yourself, you may accidentally omit these important provisions. Most business owners are not familiar with the appropriate language and may impose avoidable liability.
Omitting or Failing to Properly Prepare Bylaws
To comply with the corporate formation requirements, new businesses must prepare many documents including corporate bylaws and minutes.
Corporate bylaws serve as the corporation’s internal operating document. Bylaws must be tailored to your particular circumstances and generally detail the responsibilities, rights and duties of directors, shareholders and officers. The bylaws must also have particular language associated with the specific type of business conducted by the corporation.
For example, California professional corporations are required to include special language in their bylaws. Failure to include the required language could lead the corresponding licensing board to stop recognizing the corporation. Such language is typically not included in the bylaws provided by non-attorney incorporation services. All they provide you with is generic fill-in-the-blank forms, at an extra charge and unfortunately, the majority of business owners neglect to fill out these forms. They can be confusing and many business owners are simply unaware that they were required to do so.
Omitting Organizational Minutes
Forming a corporation goes far beyond filing Articles of Incorporation with the Secretary of State. Organizational minutes are required as a reference to business matters including the appointment of officers and directors and stock issuance. Failing to properly prepare organizational minutes can lead to the invalidation of a corporation in case of a lawsuit.
When a corporation is sued, the plaintiff’s attorney will almost always request copies of all of the corporate records in an attempt to “pierce the corporate veil.” If a corporation was organized by merely filing Articles of Incorporation, without preparing accompanying corporate records, a judge can rule that the corporate structure should be disregarded and the owners of the company should be held personally liable for the debts of the corporation.
Failing to Prepare and Issue Stock Certificates
An important part of corporate formation is preparing and executing stock certificates which bear appropriate information. Stock represents a shareholder’s ownership interest in a corporation. The actual stock certificates should be completed in the names of the initial shareholders and should indicate the number of shares being issued to each shareholder and the date of issuance. A stock ledger describing the initial stock issued to the owners and their exact capital contributions should also be prepared. Any restrictions on transfer should also be referenced on the stock certificates.
Most businesses that incorporate on their own do not bother to prepare stock certificates. Most of the non-attorney incorporation services also do not prepare stock certificates. They merely provide blank templates which are almost never filled in.
Authorizing an Incorrect Number of Shares
Another frequent incorporation mistake is to not authorize the right amount shares. The number of shares authorized can drastically increase the initial state filing fees and the annual state renewal fees. Furthermore, failing to authorize the right number of shares can impact the addition of shareholders to the corporation in the future. The share par value can also have a major impact on the initial and annual state fees. This is especially the case in states like Delaware.
Failing to Comply With Securities Laws
One of the most frequently omitted tasks when incorporating a business is complying with federal and state securities laws. Failing to comply with federal and state securities laws can have serious consequences including monetary penalties and jail time. Some states, including California, require filing of an exemption notice when the corporate stock issuance meets certain requirements.
Choosing to form your business without an incorporation attorney may lead to many unforeseeable consequences that can be damaging to your business.
Don’t Risk It – Use an Incorporation Attorney
Neglecting a single requirement when incorporating can result in monetary penalties and, suspension of a corporation’s rights and privileges and as drastic as automatic corporation termination. Additionally, neglect of such requirements can bolster a corporate creditor’s attempt at piercing the corporate veil and help their claim that the corporation was not properly formed and that the shareholders should be held personally liable for the debts and obligations of the corporation.
Learn to Delegate
Would you allow someone without proper medical training to perform a medical procedure on you or a loved one? Both medical and legal tasks should be delegated to the appropriate professionals.
Business success is often dictated by an ability to properly delegate tasks. Failing to properly delegate non delegable tasks is one of the main reasons businesses fail.
Don’t start your business off on the wrong foot. Always use a business incorporation attorney and ensure you are protected in case your business is ever involved in a lawsuit.