[box type=”note” border=”full” icon=”none”]Today’s Guest Post is by our sponsor and supporter Jeff Unger. Jeff is the CEO and Founder of eMinutes – a law firm that specializes in forming and maintaining small businesses. eMinutes is currently forming a number of free corporations for first-time entrepreneurs.[/box]
You don’t need to incorporate to start a business.
Yes, let me say it louder for those of you in the cheap seats —- it’s extraordinarily easy to start a business, and there is absolutely no requirement that you form a corporation or LLC to get a business off the ground. A lot of businesses, including my own, started as a sole proprietorship. And, if you do incorporate, you’ll have some extra costs like franchise tax ($800/ year in California) and whatever your CPA charges to prepare a corporate tax return.
So why go to the all of the trouble and expense to form a corporation if it isn’t even required to start a business? The justification for doing so is liability protection. Courts have affirmed over and over that “individuals may incorporate for the express purpose of limiting their liability”.
For some high earners, there might be some tax benefits, but incorporating is mostly about limiting your downside. The problem is that the majority of entrepreneurs think they’ve covered their downside risk by incorporating, but their corporations will not protect them when a creditor comes knocking.
There’s Way More to Incorporating Than Downloading A Form and Filing Articles
In recent years, the online incorporation industry has given many the entrepreneurs the impression that you just need to jump online and file a form with the Secretary of State.
That’s seems so easy that any smart person could do it, but the age-old adage about things sounding too good to be true applies here in a really big way. After all, you are asking our entire judicial system to let you escape liability if things go wrong, so it makes sense that you would have to jump through some pretty big hoops for it all to work. If you don’t jump through those hoops, you essentially get treated like a general partnership (i.e., a business structure with no liability protection).
There are two requirements that must be satisfied for a corporation to provide liability protection to its owners. First, you must form the corporation correctly. Second, once formed, a corporation must be properly maintained for as long as the company is in business (and even for a time after that). If these requirements are not met, then the “corporate veil” may be pierced under the alter ego doctrine and individual assets put at risk.
What it means to form a corporation properly
Forming a corporation properly starts with reserving the name and filing Articles, but those are just the first steps. Satisfying the steps for liability protection also requires preparing, qualifying and issuing shares; bylaws, organizational minutes, and other seriously important steps. Although this may seem like mere paperwork, the importance of taking care to complete each part of the process cannot be overstated. When a Court determines whether a corporation is merely the alter ego of the shareholders, one of the most important factors that a Judge is required to examine is whether legal formalities were “disregarded” when forming the company.
By the way, one thing that is not required is a pretty faux-leather corporate book and seal. Don’t waste your money on that. We live in the digital age, and corporate law recognizes that scanned documents are just fine. Here’s a list of three facts most Courts are looking for when evaluating whether to hold the shareholders personally liable for the obligations of the corporation:
• Bylaws governing the conduct of the corporation must be drafted and adopted at the corporation’s organizational meeting.
• At the organizational meeting (of which minutes must be kept), the corporation must elect officers and directors; and authorize the establishment of bank accounts and the issuance of corporate stock.
• Stock certificates must be qualified, prepared in the required manner, and issued to shareholders.
This is not an exhaustive list, but these are the “big three” of alter ego cases.
What does it mean to maintain a corporation properly?
Once formed, a corporation must also be properly maintained. An annual meeting of shareholders must be held. Other meetings of shareholders and directors may, and should, be held at the very least to discuss and authorize important business decisions. Minutes of all such meetings must be kept. States generally require the filing of reports and the payment of franchise taxes on an annual basis. The failure to pay such taxes can eventually result in the involuntary dissolution of the corporation.
Do it right or don’t do it at all
Given that protection from personal liability is often the single most important reason that entrepreneurs form corporations, it makes sense to insure that all of the necessary tasks are done right from the beginning to the end of the entity’s life. In short, it is not enough just to obtain a certificate of incorporation and then go on doing business as usual as though the corporation had never been formed.
Today’s Guest Post is by our sponsor and supporter Jeff Unger. Jeff is the CEO and Founder of eMinutes – a law firm that specializes in forming and maintaining small businesses. eMinutes is currently forming a number of free corporations for first-time entrepreneurs.
Mario Schulzke is the Founder of ideamensch, which he started a decade ago to learn from entrepreneurs and give them a platform for their ideas.