This article describes the documentation generally required for the formation of a corporation or limited liability company. While corporate documents may be drafted and filed without a lawyer, some of the more involved agreements and documentation may be overlooked in the absence of proper representation. This article discusses some of those often-overlooked documents and the reasons they are important for your business.
The most common forms of the business organization are corporations (with a Subchapter S tax election) and limited liability companies (LLCs). The documents needed to form and operate the various types of entities are largely the same, although they may have different names. For example, the document that technically forms a corporation is called the Articles of Incorporation, whereas a similar document is referred to as the Articles of Organization for an LLC. Similarly, Bylaws, as outlined below, form the governing document for management of a corporation and are referred to as an Operating Agreement in the context of an LLC.
The Articles of Incorporation (sometimes called a charter) form the corporation. This document states the company name, its registered agent (i.e., the person or company on whom service of documents may be made), the purpose of the organization, and the number of stock shares that the corporation will authorize. More often than not, this document is rather perfunctory and merely states that the purpose of the organization is “the transaction of any or all lawful business for which corporations may be incorporated under the Illinois Business Corporation Act.” Nevertheless, the Articles must be amended by a later action if the corporation decides to change its name or authorize additional stock shares. The fact that the corporation has authorized a certain number of shares does not reflect the actual ownership of the company, rather stock shares must still be “issued” to the corporation’s owners.The second foundational document for a corporation is the Bylaws. This is essentially the constitution of the organization. It sets forth the location of the corporate offices and provides specifications as to what actions may be taken by shareholders, directors, and officers, as well as what constitutes a quorum and a successful vote for each group on various matters. In terms of the governance of the organization, the stockholders, as owners of the company, are generally less involved in the day-to-day operations as compared with directors and officers. The board of directors is more involved in the day-to-day operations and often meets regularly. The officers are the most involved, “on the ground,” individuals who run the day-to-day operations of the company. Officers may be employees hired by the board of directors.
Careful consideration must be given to how an organization wants to run itself when drafting the Bylaws. This is something that is frequently overlooked, and companies find themselves in a situation where they desire to take certain corporate action but are prevented from doing so by an overly restrictive set of Bylaws or a set of Bylaws that does not match the practical realities of the particular company.
In addition to the Bylaws of the organization, the shareholders and board of directors must have an initial meeting which documents various initial actions. For example, in the meeting of the shareholders, the directors are elected, and the Articles of Incorporation are approved by the company. In the initial board of directors meeting, the bylaws are adopted and officers are elected. Additionally, the company is authorized by the initial board of directors meeting to issue shares to shareholders. Careful minutes should be kept of these initial meetings, as the meetings are required under Illinois law. Further, the corporate shield of liability, an important reason for formation, requires that corporate formalities be maintained, including meeting and authorizing various corporate actions in the proper manner.One of the most important documents, often overlooked in the absence of counsel, is a shareholders’ agreement. This is a contract between each shareholder and the company with regard to the ownership, transfer and sale of their stock shares. In the absence of a shareholders’ agreement, the shares owned by a given shareholder are treated like any other asset of that shareholder. When one shareholder passes away, for example, it can often be challenging for the corporation to deal with the transition of those shares under either the will of the deceased shareholder or the statute governing inheritance. Further, the individual who inherits those shares may be someone the corporation does not desire to be a shareholder. These are the types of issues that are dealt with in the shareholders’ agreement. Often the shareholders’ agreement will provide that, in the event a shareholder passes away or becomes disabled, the company has a right to buy those shares under certain agreed terms.
Similarly, a shareholders’ agreement will typically specify that, in the event any shareholder desires to transfer or sell his or her shares, he or she must first offer those shares to the corporation at the same price or at some other price designated by the parties. A shareholders’ agreement often provides for so called “go-along, take-along” requirements. A “take-along” provision provides that when a certain percentage of the shareholders desire to sell their shares of the company, they can require the minority shareholders to participate in the sale under the same terms. Similarly, a “go-along” provision provides that a group of minority shareholders may require that they be included in any sale of the majority of the shareholders’ shares.
Another important document is a subscription agreement, a contract between a single shareholder and the company. Similar to the shareholders’ agreement, a subscription agreement sets forth certain restrictions on the transfer of stock. However, it also contains certain representations by the shareholder, such as that the shareholder is accepting the risk of the investment and cannot therefore later complain as to having not received sufficient information (a securities law issue).
There are several additional documents beyond the scope of this article that should be considered in corporate formation. Certain documentation is necessary where, for example, an initial employee of the corporation may acquire ownership over time by providing sweat equity in the early stages of a company’s development. Often such arrangements will be placed into either an Operating Agreement or other documents which provide that where the company meets certain benchmarks over time, the founding individual may acquire shares under a given formula.
At Heyl Royster, we work with your business from
the early stages of corporate formation to ensure the initial documents are in
proper order and provide a sound foundation for the company to grow and expand.
Proper formation and documentation is important so as to provide sufficient
control over time. We can also analyze your existing corporate documents and
provide recommendations for updating them and adding documents that may be
desired based on the needs of your company, including such matters as