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The Basics of Corporate Governance

In my role as an attorney representing emerging growth technology companies, I spend a lot of time talking to and working with entrepreneurs as they prepare to start new companies. This is the third in a series of five posts that I will write exploring some of the legal and practical business issues that aspiring entrepreneurs need to understand as they begin this process.

Picking up where we left off last time, you have decided that your startup is the next Facebook and you have formed a corporation that will provide the foundation of your business empire. First, we will discuss in which state you should incorporate your corporation and then discuss a quick overview of how a corporation should be run. Keep in mind that in order to receive the benefits of a corporation (such as protection of your personal assets) it is important that you run your company as its own entity and not an extension of yourself - keep good records, observe corporate governance formalities and don’t intermingle personal and business funds.

Why Should I Incorporate My Company in Delaware?

Most of the technology companies that you have heard of (and over ½ of all Fortune 500 companies) have been incorporated in the State of Delaware, even if their founders couldn’t pick Delaware out on a map, for some or all of the following reasons:

  • Delaware’s corporate law is flexible, and is understood by virtually all corporate lawyers in the country, regardless of where they practice
  • Delaware has a well established, detailed case law that provides some legal certainty as to what is or is not permissible
  • Delaware case law is generally very director friendly - when you get sued (and you will be sued if you are successful) better to be in Delaware
  • The Delaware Secretary of State’s office is very responsive and technologically advanced, which will be important to you when you are trying to close your venture round before you miss payroll the next day
  • Last but not least, your investors (particularly venture capitalists) will likely require you to be a Delaware corporation 

Don’t worry if you are already incorporated in another state, switching your state of incorporation can be a relatively painless procedure. If you are beginning to take a look at Delaware formation, you will no doubt notice that being a Delaware corporation isn’t cheap, but the positives, generally, far outweigh those costs.

Corporate Governance Overview

Board of Directors
The Board of Directors are elected by the stockholders of the corporation and are responsible for overseeing the operations of the corporation and ensuring that its actions are in the best interests of its owners (the stockholders). Most important decisions to be made by the corporation will require the approval of the Board of Directors - and the most material of those will also require the approval of the stockholders (see table below). Be judicious in who and how many directors you appoint, especially early on in the life of the corporation. Too many directors can create unnecessary logistical headaches - especially since you need to be very agile in the early days. Also, be wary of potential directors that ask for monetary consideration. Some small equity grants are not unusual, but your cash is generally better spent on product development.

The officers of the company are appointed by and serve at the pleasure of the Board, and are responsible for executing the business strategy set forth by the Board of Directors. Assuming your corporation was incorporated in the State of Delaware the only officer positions that are required to be filled are the offices of the President and Secretary. All other positions that you will likely create (Chief Executive Officer, Chief Yahoo!, etc.) are corporate titles created for the benefit of your corporation and have no legal meaning in the eyes of the government.

Board of Advisors
I stated above that you should be very judicious about who and how many directors you have on your Board of Directors.  It can be very beneficial for your company and for your fundraising efforts to associate yourself with industry luminaries who will give credibility to your new venture.  Instead of adding them to your Board of Directors, you should consider adding them to a Board of Advisors. There is no governance responsibility for the advisors, however, it will formalize their association with your company and allow you access to their brainpower and reputations.

Actions Requiring Board and Stockholder Approval
The lists below are a useful reference to know which actions of the corporation require Board and/or stockholder approval (remember that obeying corporate governance formalities is important if you want to receive the benefit of the limited liability protection afforded by the corporate entity):

  • Board Approval Required to:
    • Amend the Certificate of Incorporation
    • Enter into fundamental corporate transactions (sale of company, merger, sale of substantially all assets of corporation, etc.)
    • Appoint officers
    • Issue securities that will affect the capitalization of the corporation (issuing shares, issuing stock options, etc.)
    • Enter into material agreements (agreements that have a disproportionate impact on your business – lower threshold in early days)
    • Compensation / arrangements with officers 
  • Stockholder Approval Required to:
    • Amend the Certificate of Incorporation
    • Enter into fundamental corporate transactions (sale of company, merger, sale of substantially all assets of corporation, etc.)
    • Elect Directors (though vacant seats from departed directors can often be filled by Board)
    • Establish stock option plans and any amendments to same
    • Permit interested director transactions (transactions in which a member of the Board has a direct financial interest – such as when the corporation licenses software from a separate company that is owned by a member of your Board)

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