If You Insist
© 2007 Kevin E. Houchin
In the past month I’ve had several people in the office with messed-up corporate situations. I’m not going to preach (much) about how it costs way more to get out of trouble than to have avoided it in the first place, but just know that the legal bills to sort out these messes are probably going to be ten times the price of correctly forming a company from day one.
Most of the time, companies are easy to set up. The buy-sell agreement is usually the most challenging part. However, to effectively set up a corporation, you need to jump through more formal hoops, and the companies I’ve been talking with lately simply didn’t make the right jumps.
So, if you insist on forming your own corporation without the assistance of a lawyer, here are my thoughts on the minimum amount of work you need to complete.
1. Set up the entity on the Secretary of State Web site.
This is the easy part. The filing fee is only $25.00. The biggest mistake people make on the form is messing up the authorized shares listing. Your initial authorization of shares is an important decision and it depends on a bunch of factors relating to the number of owners involved at incorporation, or expected in the near future. I suggest authorizing 100,000 shares. This gives you some room to work, as I’ll discuss below.
2. Get an EIN number from the IRS.
Again, this is easy. Go to www.irs.gov and follow the instructions.
Unfortunately, most people stop here and head to the bank. The bank doesn’t care about many of the details and formalities. If you insist on conducting business in the corporate form, you need to complete the next several tasks.
3. Adopt a set of corporate by-laws.
These are the rules about how your company will be managed. The way you go about adopting these agreements is by holding an initial meeting of incorporators in which you make resolutions to play by these rules.
4. Adopt a buy-sell agreement.
This document regulates the purchase and sale of your corporate shares. It should include a valuation formula for the business and the rules for leaving or pushing someone out. This document is critical. Getting into business with someone is like a marriage except the owners generally can’t kiss to make up. The buy-sell agreement is the business equivalent of a pre-nuptial. Don’t go into business without it.
5. Create and accept subscription agreements.
These letters are the written offers from the initial shareholders to purchase shares of the corporate entity for some amount of value – usually cash. I have all the initial shares issued to the initial owners add up to LESS than the full number of shares authorized in the Secretary of State filing. Having some shares that are not “issued” at formation makes it way easier to bring in future owners, because then you just have the new shareholders buy their shares directly from the corporation rather than from the initial individual owners. Doing this also saves making another filing with the Secretary of State to authorize additional shares.
6. Create share certificates.
Share certificates are proof of your portion of ownership in the company. It’s hard to prove you own “shares” of a corporation when you don’t have the actual “share certificates.” Amazingly, people have been known to invest a lot of money as an “owner” of a corporation without ever seeing a share certificate. Don’t let that be you. (Of course the exception to this rule is buying shares in publicly traded companies. Your brokerage firm holds those share certificates.) You can order corporate kits online with a seal, share certificates, and standard by-laws that allow you to just fill in the blanks. Be careful just filling in the blanks, because standard forms might not fit your specific situation, but filling in the blanks is usually better than ignoring the document completely.
7. Elect a Board of Directors.
Your Board of Directors runs the company on behalf of the shareholders. In most small “closely held” corporations, the list of board members and the shareholders are virtually identical. As the company gets bigger you might have shares held by folks who are not actively involved in the business. Remember, in a corporation, the Board makes the decisions on the day-to-day management. The Board can be one person, or as large as you want (as specified in the By-laws you adopt). If you have several shareholders you should have at least a President, Secretary, and Treasurer as officers of the Board of Directors. At least two of these people should be required to approve any serious action of the corporation. There are additional rules for certain corporate actions that require shareholder approval, such as selling the company.
8. Bank Accounts
I’ve seen several situations where there was no direction or restrictions put on the bank accounts, which resulted in one person transferring all the money out of the corporate account or taking another owner’s name off the account. If you want to protect the corporate money, then protect the corporate bank account. Require corporate action signed by two directors (President, Secretary, and/or Treasurer) before someone’s name can be taken off an account. Require two signatures for transfers over certain dollar amounts or for transactions that would bring the account to a zero balance. Talk with your banker to effectively establish these practices right up front. Don’t get burned by finding out your co-owner has just cleaned out the funds and taken your name off the corporate account.
If all this sounds like too much work, reconsider your venture, or hire professional help.
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Kevin E. Houchin is principal of Houchin & Associates, PLLC – a copyright, trademark, arts & entertainment, business development, and branding firm located in Fort Collins, Colorado. To contact Kevin, call 970-493-1070 or email kevin.houchin@houchinlaw.com. Download Kevin’s FREE ebook: “Strange Fire: 5 Winning Principles” at www.guidingvalue.com.