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Forming a corporation is a bit like entering into marriage: all the parties need to agree beforehand on how the corporation will work, i.e. what rules the entity will generally function under. Taking the time early on in the formation of the corporation to discuss and implement corporate operating documents will help avoid disruption and additional costs, especially legal fees, later on when disputes almost inevitably arise.
Time and time again, when individuals get together to form a corporation, they are, at inception, like-minded, and therefore do not bother to draft the basic rules governing their relationship. This is always a mistake.
When forming a corporation, there are three basic documents to get up and running:
•the shareholders’ agreement;
•the articles of incorporation; and
•the corporation’s by-laws.
There is an important balance between these documents that can be very technical, especially for non-lawyers. There are certain items that are allowed and/or disallowed by state law based on where those terms are included in the corporate formation documents and some operational parameters are only permitted if they are found within two or more of these three documents. It’s important to seek an experienced attorney to assist in their drafting when handling these start-up matters.
Here are some of the most significant issues that you will want to address when forming your corporation:
It is critical to grant shareholders’ rights to appoint and remove directors. The weight of a shareholder’s vote may correspond with the amount of equity which he or she owns in the corporation, but all shareholders should have a right to vote for both the admission and removal of directors from the company’s board, as these are the people who will actually run the company.
You also want to have a number of terms to protect the minority shareholders. This can be accomplished by requiring, in closely held corporations, a unanimous vote for certain major corporate decisions. These actions could include selling a majority of the corporation’s assets, selling the entire company to a larger entity, changing the nature of the business, taking on significant debt, taking the company public, or even dissolution. All of these are the types of major actions that often require unanimity from the shareholders in a closely-held corporation.
Stay tuned for part two where we will continue the discussion about must-have legal documents and procedures for start-ups. Contact us today with questions or comments.