Now What: You’ve Messed Up Corporate Formation

I get quite a few calls from clients that MESSED UP their corporate formation.

  • Owners are afraid of being SUED because their entity is not “formally” set up
  • The State Franchise Tax Board has SUSPENDED the entity
  • NO ONE has been ISSUED any equity (stock if a C corp; units if an LLC)
  • NONE of the owners have a  shareholder agreement (e.g. c corp) or
  •  operating agreement (e.g. LLC)
  • Directors are ONE THE HOOK for anything that GOES WRONG
  • Someone has left the entity and there is NO RIGHT TO REPURCHASE

Some of these problems are EASY FIXES.

  1. Let’s Diagnose YOUR Problem

First – let’s compare notes.  Do you have all of the below?

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2) Let’s drill down one more level.

a) DO YOU USE UNANIMOUS WRITTEN CONSENTS in lieu of Annual Meetings of Shareholders or Directors?  √ CHECK

–> (Note: LLC’s use Resolutions.)

b) Do your Unanimous Written Consents (or Resolutions) specify ALL material events to your shareholders or directors? √ CHECK

By material – I mean, that any event or decision or information that a reasonable person would need to make an informed decision.  Are we on the same page?

[the SEC defines materiality as: “to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered.”

Practice Tip: Consider being as specific about what you put into these Consents and Resolutions.  They can be used to disclose an entity’s important (ie. material) facts and events and can serve as a chronological record of the decisions made by the entity.

3) What is the status of these documents:

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Have ALL shareholder’s executed a stock purchase, shareholder or if an LLC – an operating agreement?

Are there differences in the agreements between these individuals?

If so, is that because some have more or less rights than others?

Fiduciary duties:  In the LLC context, did you limit the duties that one member has to the others or between the manager and any member?

Deadlocks: How do you resolve deadlocks? If there are only two owners and they each own 50% of the equity, how will you resolve a deadlock?

Rights to Repurchase or Buyouts: What triggers the rights? what is the method of valuation? Does one equity holder have the right to force another equity holder to buy them out (ie. they have a put) versus the Company or a member have the right to buy away the equity of another member (ie. an call like option?).

4) Tax Matters: Many suspension and reporting problems come about because the tax preparer, advisor and the Client are not communicating about the following items:

screenshot-2016-11-14-15-37-03

 

IF YOU WOULD LIKE TO GO THRU MY APPROACH TO FORMATION, PLEASE GIVE ME A CALL 310-570-2399.  I offer fixed or flat fee programs for various scenarios. 

 

 

Cleaning Up Your Business

For years, prospective (and current) clients call me often with the following problem: they are entering into a transaction that requires them to confirm that their corporate documents are up to date.  I thought I would jot down a few notes for everyone so that they have  a checklist to start this work on their own. And if you need me to help along the way, don’t hesitate to ask. Or go to the Secretary of State Website (California’s see http://www.sos.ca.gov/business/be/faqs.htm).

Disclaimer: The reason you keep entity formalities is to ensure that the entity is separate from other entities – including your individual person. If you do business as an LLC or S-corp or C-corp however, there is no guarantee that you will not be sued as an individual. In fact, I often see individuals sued with their entity.  However, if the claim against you is essentially a claim against the entity – you are alleged to have done something, as a corporate officer, in the name of the entity, AND you have maintained corporate formalities, then even if you lose the lawsuit, the partying suing you is less likely to be able to go after non entity assets for recover. Notice I said less likely?! The devil is in the details.  I will be happy to – at no charge – high light for you whether or not your existing entity has maintained corporate formalities and point out potential gaps in your veil of protection.

1) Step One: Find what you’ve already done. 

a)  Filing with the secretary of state.  If you’re a California entity – C corp, LLC or partnership, and registered with the state of California (or any state) someone filed various registrations with the state when you were established.  If you are an S-corp, remember you need to make an election so talk to your CPA. (see: irs.gov S Corporation Fact Sheet for details.)

Find those first forms. They will most likely include: Certificate of Formation, Articles of Incorporation, the entities’ first Statement of Information (which lists officers and directors); Bylaws.

b) Every year: Did you file statements of information each year? Find the ones you filed.

c) Did you or the founder actually purchase the initial stock, membership or partnership interest? Did they pay cash for the rights? How much?

d) Did you hold or have actions in lieu of a shareholder’s meeting?

e) Is there a business license for the entity in each city or state that requires a license to operate?  How about a doing business as (aka Fictitious Business Name) filing? One is required unless the entity is doing business name in its own name. For example, let’s say the entity is ABC LLC but does business as The A Solution.  A fictitious business name filing is required for the “The A Solution” so that someone interacting with it in the marketplace is on notice that it is actually the ABC LLC and not some other entity.

f) Insurance policies? Are they in the name of the entity?

g) Other rights owners? Did the founder orally or in writing offer or grant rights to anyone else? Get those existing papers together.

h) Did you get an EIN?  Go to IRS website. There is no filing fee.

i) Payroll taxes enrolled and paid? In California, go to EDD. I recommend you engage a payroll service like surepayroll or adp to handle payroll and pay and file payroll returns.

This list does not address contracts and proprietary rights that the entity might have. 

2) Clean Up: 

a) Often, when the entity was formed, no one (i) made sure the founder purchased her/his initial rights; (ii) gave the entity it’s initial powers via organizational minutes; (iii) appointed the proper number of directors (you need at least one in California and no fewer than two if there are more then one shareholder); (iv) held a shareholder mtg annually or took a corp act in lieu of a shareholder meeting).  Which ones of these did you not do?

b) To catch up: Write in a chronological fashion, all of the major events of the business since formation: For example, January 2011, one shareholder Jim, decided to lease space at 123 Main and on January 2012 decided to offer employment to initial employee Sally. In January 2012, Jim decided to enter into long term lease for 123 Main and we paid Sally X.

Bylaws: Your by laws – if you are a c-corp, your operating agmt if you are an LLC and your partnership agmt if you are a partnership – will dictate when you are to hold shareholder and/or meetings of board of directors.  If you want to ensure that you maintain the corporate form, you should take notice of these things.

Shareholder minutes: These are technically notes from a shareholder meeting: I encourage you to use services like Rocketlawyer.com but they are not free and they are not lawyers. If you do, you might get corporate minutes to include all of the bells and whistles but are not required.  For example, My Corporate Minutes is a Rocketlawyer.com produced minutes. I do not confirm that this is compliant with any state law but it is an example.

Shareholder consents: If you did not have actual meetings, you will need annual consents in lieu of a shareholder meeting or meeting of board of directors. Often, when the shareholder is one and the director of the entity is the same as the sole shareholder, you will have Annual Consents of Sole Shareholder and Director In Lieu of Meeting. Here is a ANNCONN annual consent in lieu of meeting. Again, use these forms at your own risk.

d) Have your current statement of information filed timely.

e) Pay all back payroll taxes and income taxes. Engage a CPA if you are behind to deal with penalties and late filings.

f) Once you have your minutes done, you will want to use the chronology to clean up your annual shareholder meetings. It is in these meetings that you.

g) Valuations: There has been a lot of discussion about valuations lately. If an entity offers stock to any stake holder, it will be important to know the value of the entity when the shares are granted.  Subsequent discussions will address IRC 409A Valuations Final and fairness duties to minority shareholders.

For further information and help, do not hesitate to call me.