Formation of Corporations and LLCs
General Corporate Matters
In order to form a corporation, a Certificate of Incorporation or Articles of Incorporation must be filed with the Secretary of State of the state in which the company will be incorporated. The certificate or articles are usually signed by a sole incorporator, whose only function is to create the company. This organizational document generally states the name of the corporation, the capital stock structure, the corporate purpose, and the registered agent and office of the corporation. The sole incorporator then signs a consent appointing the initial directors of the company.
The initial directors take action in an initial meeting or by written consent to perform the following actions necessary to start the company: elect officers, adopt bylaws, adopt a form of stock certificate, issue shares of stock, provide for banking resolutions, establish the fiscal year, and provide for foreign qualifications. This action will also provide for the resignation of the sole incorporator. In the board of directors’ initial meeting or consent, they will decide whether the company should make the necessary filings to qualify for the Subchapter S election with the IRS. This election provides for pass-through taxation, rather than the standard taxation one generally finds with a Subchapter C or regular corporation.
The bylaws of the new corporation, as approved by the board of directors, set forth the rules and procedures for meetings of the board of directors and the stockholders. They also describe the duties and authority assigned to corporate officers, and may place restrictions on the transfer of stock.
In connection with the issuance of stock in accordance with the initial board meeting or consent, the new stockholders may be required to enter into restricted stock purchase agreements. Under a restricted stock purchase agreement, the corporation has a “purchase option” on the newly issued shares, and the shares are released from this option over time according to a predetermined schedule. If the company does not wish to provide for this type of “vesting” of shares, the initial stockholders may instead enter simple founder’s stock purchase agreements, which merely provide the terms for the purchase of the shares. If the corporation has or expects to have employees, outside board members, or consultants, the board may wish to institute an equity compensation plan. Under an equity compensation plan, the board of directors may, from time to time, issue stock options or restricted stock to employees, directors, officers, consultants and advisors of the company.
General Limited Liability Company Matters
A limited liability company, or LLC, is formed by filing articles of organization or a certificate of formation, usually with the Secretary of State of the state in which the company is to be created. This document, like the Certificate of Incorporation for a corporation, sets forth the name and registered agent and office of the newly formed entity. Different states have different rules regarding the information required to be included in this charter document, so statutes should be consulted in the jurisdiction in which the LLC is to be formed.
Once the Certificate of Formation or Articles of Organization has been filed, the only document that needs to be prepared is the Operating Agreement or Limited Liability Company agreement for the LLC. This document addresses the governance of the LLC, the allocation of membership interests in the LLC, the sharing of profits and losses, and virtually any other contractual item that the parties involved wish to include. An LLC may be managed by its members or by one or more managers, who function in a manner similar to directors.
General Matters for New Businesses
Whether forming a corporation or an LLC, the following matters may need to be addressed as well.
The company’s name can be reserved prior to formation in both (i) the jurisdiction where the entity will be formed and (ii) any jurisdiction where the company may be doing business. Post-formation, the company should file an application for certificate of authority or other evidence of foreign qualification in each state where the company anticipates doing business. If it is uncertain as to whether the activities the company is performing would constitute “doing business” within a given state, the company should review the statutory requirements of that state. The company may be required to obtain licenses or permits from local governments or municipalities. It may also need to register to pay sales and use tax in various states where its products are sold. Additional filings will be necessary if the company intends to do business in any jurisdiction under an assumed name. The company should also obtain a federal employer identification number from the IRS.
The company should consult with counsel regarding employment laws in each jurisdiction where the company has employees. As an example, businesses may be required to display posters regarding certain of their employment policies. New companies should also look into finding a payroll processing company to ensure their compliance with laws regarding tax withholding, unemployment insurance accounts and related payroll issues. Companies will want to develop a form of offer letter that they can use in connection with the hiring of new employees, particularly if they intend to make offers to hire only “at will” employees.
In addition, it is important to distinguish between employees and consultants. Working with employment law attorneys will ensure that a company’s consultants are not viewed as employees by the state or federal government.
Finally, all employees and consultants, prior to beginning work, should sign agreements containing confidentiality clauses and protecting the company’s intellectual property rights, including provisions giving the company ownership of intellectual property developed by such employees or consultants. The company should also consider non-competition covenants, which must be carefully structured to ensure their enforceability. For new employees, these non-competition agreements must be signed prior to their beginning work at the company.
The company should reserve a domain name and may need to do trademark searches or make trademark filings. If the company does not own the intellectual property it will be using, it should obtain a license or assignment from the owner (for a founder, this assignment may be part of the consideration for his or her ownership in the company). The company will want to consult with a patent attorney at an early stage regarding any intellectual property that may require patent protection.
- Company organized as a corporation or LLC.
- Company qualified to do business in every state in which it is transacting business.
- Bylaws or Articles of Organization have been prepared.
- Organizational consents have been signed by the directors, members or managers.
- Ownership has been divided and stock certificates, if applicable, have been issued with
- Officers have been elected for the company.
- Directors or managers have been elected/appointed for the company.
- A Chairman of the Board of Directors, if applicable, has been elected.
- Stock option plan has been adopted.
- Stock options have been awarded by the Board of Directors.
- Stock option agreements have been issued to employees who have been awarded options.
- An employer identification number has been obtained.
- Company has obtained a URL for the appropriate names.
- The company has filed for trademark registration for appropriate product and service names.
- The company has obtained a lease for space.
- The company has complied with both state and local license requirements.
- The company has registered with appropriate states for sales and use tax requirements.
- The company has registered for any available state tax credits.
- The company has retained legal counsel.
- The company has retained an independent certified public accounting firm.
- If appropriate, the company has filed for Subchapter S election.
- If appropriate, 83(b) elections have been filed for holders of restricted stock.
- Invention, non-disclosure and non-competition agreements have been entered into with all
employees and consultants of the company.
- All outside directors have signed non-disclosure agreements.
- Agreements have been entered into with scientific advisory board or business advisory board members.
- A business plan has been prepared for the company.
- Any copyrightable materials have been registered with the U.S. Copyright Office.
- The company has checked with patent counsel to determine if any of its inventions are
- The company has adopted an employee handbook with appropriate policies on all personnel matters.
- The company has appointed a registered agent in the required states.
- The company has considered whether it needs a buy-sell agreement among its owners.
- File W-4 and state forms for withholding taxes.
- Obtain I-9 (Employment Eligibility Verification) from each employee.
- Obtain signed offer letters from all employees.
- EEO, Minimum Wage, FMLA, OSHA, Employee Polygraph Protection Act, Notice to
Employees with Disability, Uniform Services Employment and Reemployment Rights Act, and state workplace laws posters must be displayed. Call 1-866-487-2365 (Federal).
- Obtain workers’ compensation insurance if required.
- Keep appropriate personnel records.
- Prepare job descriptions for all positions.
- Employ payroll services company.
- Establish review procedures for employees.
Confirm that exemptions are available for all sales of securities (including option grants) and that all required filings, both Federal and State, have been made.
This article was originally published in the Business Leader Media Guide to Selecting a Legal Structure