A corporation is formed by delivering a charter document called the articles of incorporation to the appropriate state authority and paying the appropriate fees. The corporation actually comes into existence when the state authority, usually the attorney general’s office, accepts and files the articles of incorporation. The Articles of Incorporation is a chartered document mandate by statute. This is a public document that can be easily accessed by anyone. For this reason, often it is drawn to include only the minimal provisions which typically include the identity and address of the incorporators, the corporate name, the registered agent and office of the corporation, the number of shares of stock that the corporation is authorized to issue, and usually but not always, the number and identity of the initial directors of the corporation.
Here, it is critically important that the state’s default rules regarding certain matters be carefully evaluated. If a default rule is ill advised or unacceptable, sometimes it must be negated in the Articles of Incorporation. If for example the state’s default rules mandate cumulative voting rights that favor minority shareholders or preemptive stock purchase rights that give existing shareholders priority rights when more stock is going to be issued, the key players often want specific provisions included in the articles of incorporation that negate, wipe out these types of minority rights that may restrict flexibility or complicate decisions down the road.
Similarly, depending on the state corporate law, often it is necessary and desirable to include in the Articles of Incorporation specific provisions dealing with the limits of the director’s potential liabilities, the indemnification of directors and related expense advances, special shareholder consent voting procedures that eliminate the need for any shareholder meeting by authorizing the use of a shareholder written consent resolution for less than all of the shareholders. The authorization of blank check preferred stock – stock that can issued down the road by the board with preferred rights, and super majority shareholder voting requirements.
The specific provisions that need to be included in the articles of incorporation will depend on the objectives of the parties forming the corporation, those who are calling the shots, and the statutory default rules of the particular state in which the corporation is being organized.
In addition to the articles of incorporation, a corporation must have by-laws. The by-laws serve as kind of the owner’s manual for the corporation. This document describes the role of the shareholders, directors, and officers; the mechanics for calling and holding meetings; and handling other administrative and procedural matters. Key provisions often include the number of directors, the authorized use of electronic transmissions for shareholder notices, specific meeting notice requirements, the time and place of the annual meeting, authorized participation via communications equipment, authorized board actions without a meeting, board of director compensation authorization, officers’ duties and titles, stock certificates and legends, stock transfer restrictions, indemnification provisions, fiscal year designation, by-law amendment procedures, and often special tax elections. Unlike the articles of incorporation, the by-laws are not a public document.
Then there are employment agreements. These documents govern the employment relationship between a corporation and its key employees including those employees who are also shareholders. These employment agreements are used to document important deal points, the term of the employment, how long it will last, termination rights by either party, compensation benefits, non-compete provisions, confidentiality covenants, intellectual property rights, default remedies, and whole host of other employee-related matters.
The organizational resolutions of a corporation are a key component of the organizational documents. These are resolutions approved and adopted by the board of directors in order to organize and start up the business. These resolutions usually include provisions approving the articles of incorporation, adopting the by-laws, electing the officers, authorizing the issuance of stock and the receipt of consideration for the stock such as money, property or services, authorizing the establishment of corporate bank accounts, ratifying and approving any pre-incorporation business transaction taken by individuals who are forming the corporation, approving credit lines and other financing arrangements, authorizing the commencement of the business’ operation, authorizing the execution of documents necessary for the acquisition of assets, leases, licenses and intellectual property rights, and approving any other significant matters relating to the start up of the business. These organizational directors’ resolutions are documented either as written consent resolutions which must be signed by all of the directors or as minutes of an organizational meeting where the directors meet and approve the specific resolutions.
There is also a stock register and stock certificates. Stock certificates are issued to the shareholders. For privately held corporations usually each certificate will include printed legends on the certificate that give notice to anyone who views the certificate that an agreement exists between the corporation and its shareholders that prohibits and restricts the transfer of corporate shares and that the shares have not been registered under the applicable securities laws and are subject to transfer restrictions under those laws. The stock register is an official record of when specific shares were issued and to whom they were issued.
Often specific asset transfer documents are needed to transfer specific assets into the corporation. Examples include bills of sale, lease assignments, license agreements, and in rare instances, real estate deeds. Sometimes the documents include provisions requiring the corporation to assume liabilities relating to the transferred assets. Also, certain transfer documents such as lease assignments will require the consent of a third party.
Pre-incorporation agreements are also an option when a corporation is going to be formed. In some situations, the parties’ desire to document their mutual understandings regarding the formation of the corporation and their approval of the terms and conditions of all of the organizational documents before any steps are taken to officially form the corporation. This is accomplished with a pre-incorporation agreement – a comprehensive document that lays out the whole game plan in advance and usually includes as exhibits drafts of the other organizational documents that are going to be used. This document sometimes is necessary in order to commit key players to the venture. Unlike the articles of incorporation, the by-laws, and the director’s resolutions, it is not a required document and many corporations are formed without a pre-incorporation agreement.
There are also required government filings when a corporation is set up. Each state requires that certain documents be filed and that fees paid in order to form the corporation. Typically, these documents include the articles of incorporation, the written consent of the registered agent of the corporation, and an application to obtain a state tax identification number. Also, a form SS-4 needs to be filed with the internal revenue service in order to obtain a federal tax identification number and sometimes a form 2553 is required if an S selection is desired.
And finally, there is the shareholders’ agreement – an agreement between the shareholders of a closely held corporation that is critically important in nearly all situations. Sometimes it’s called a buy-sell agreement. For planning purposes, this agreement usually is the most important document by a long shot. It lays out the terms of the buy-sell provisions among the shareholders and the details of those operational deal points that the shareholders have chosen to document between themselves. This is not a required document and it shamefully ignored in far too many situations. It usually takes more work, more dialogue, and more customization than any other organizational document.
Although the authority to manage a corporation is vested in its board of directors, state corporate statutes authorize the use of a shareholders’ agreement to establish rights among the shareholders of a closely held corporation – those corporations whose stock is not publicly traded. And these rights, as agreed to by the shareholders, will preempt the management authority of the board of directors. The shareholders’ agreement should be carefully drafted and should specify how long it will remain in effect. Absent such a provision, some state statutes may terminate the agreement after a designated term such as ten years. The agreement should be conspicuously referenced in written legends on all stock certificates that are issued by the corporation so that anyone getting a stock certificate will know that such an agreement among the shareholders is in effect.
A carefully designed shareholder buy-sell agreement may accomplish many important objectives of the parties. It can ensure that stock in the company is never transferred or made available to third parties who are unacceptable to the other owners. It can provide a mechanism to fairly value and fund the equity interests of a departing owner. It can help ensure that control and ownership issues will be smoothly transitioned at appropriate times and that all owners will have a fair market for their shares at appropriate points of exit. When necessary, it can lay out how the shareholders can involuntarily terminate, expel a shareholder who is no longer wanted. The agreement also can help lock in the value of a deceased shareholder’s stock for estate tax purposes so that the estate tax value does not exceed the buyout value and create an ugly estate tax exposure for the shareholder who has recently died. Plus the agreement can help ensure that cash and funding challenges of owner departures are appropriately anticipated and covered.
To protect the business, usually there is a need to lay out payment terms in the agreement including mechanisms for determining the duration of the payments, the interest factor, and any special relief provisions for the company. And as previously mentioned, the agreement can lay out key operating deal points which are often very important to investors who are considering purchasing an interest in the company. These provisions effectively lock the hands of the directors and can provide valuable minority rights.