Seven Myths About Incorporation For Small And Medium Enterprises

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BAY OAK LAW

Oakland, CA

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Practice Areas: Intellectual Property

1. Incorporating Is The Only Way to Shield My Assets If There Is a Catastrophe.

Starting a small business has its risks. It takes a lot of work, there are lots of long nights, and it needs a lot of resources, which leads to a lot of worries. What if the product somehow goes wrong, making people sick? What if I mess up in providing services? Is a corporation the only way to shield my assets?

A corporation can be a good way to protect an owner in some situations. It can protect the owner for a lot of contractual issues – although owners may have to personally guarantee some of them, like leases. It is highly recommended when the business has employees. However, owner/operators are vulnerable to the most catastrophic losses, such as when the owner is involved in some type of misdeed, deliberate or otherwise.

Liability insurance is a better way of protecting assets in the case of catastrophe for all businesses, but especially for small businesses.

2. Gotta Incorporate In Delaware.

“Hey, all the big companies are in Delaware. We’re gonna be big, so we have to be a Delaware corporation, too.”

Delaware is a good choice for corporations that have a lot of shareholders and capital. It provides a lot of discretion for the officers running the corporation, when the shareholders are not active in the business. However, small businesses don’t need that structure – their shareholders are typically very active in the business. Moreover, if the business is physically located in your home state, then it has to be registered (and documents like tax returns filed) in both your home state and in Delaware. There is no reason to pay two states if you only need to pay one.

But as you said, you’re gonna be big. In that case, there are ways of re-incorporating in Delaware – but that can be done when it is easier on your cash flow and profits.

3. We Need Lots of Shares.

Remember during the first internet boom, when share certificates were as common as, well, paper towels? People got the idea that the more shares you have, the greater all of it is worth. Alternatively, there is the idea that shares of publicly-traded stocks should be worth between $1.00 and $100 each, so that they are accessible to the public. Neither of these ideas are applicable to the starting of a small business.

The shares aren’t publicly traded, so there is no need to worry about their public accessibility. Investors are less interested in the number of shares than the percentage of issued shares (and thus control of the company) that they can hold. Berkshire-Hathaway has shown that single shares can go for more than $200,000 each, and still have plenty of liquidity.

4. Gotta Give All Those Shares Out.

Moreover, the number of issued shares should not be the same as the number of authorized shares, at least at the outset. What’s the difference? The number of authorized shares is the maximum number of shares allowed. Knowing this and comparing it to the shares you have will give you a worst case analysis. But the only shares that count are the shares that are actually issued. A young corporation is going to want to have plenty on hand in case new investors appear.

5. We Gotta Have a Company Be Our Registered Agent.

A registered agent is authorized to accept service of complaints and governmental documents on behalf of the corporation. There are companies whose business it is to accept these documents and pass them on to the company. Some of them, like CT Corporation, are quite reputable, and provide services besides just waiting. However, individuals can and do serve as registered agents, and can do so without cost.

6. Bylaws – Just Grab and Go.

Many startups don’t focus on the paperwork involved until it is far too late. You don’t want to find out that the bylaws have tripped you up because you weren’t aware of them. These need to be examined to be sure they meet your needs. Moreover, some incorporators still use bylaws which are decades out of date: I came across a company incorporated about ten years ago that still required notice of shareholder meetings to be sent via telegram, which can be a little hard to do in the modern age.

7. Two BFF Directors is OK.

We know: you are best friends, brothers from other mothers, sisters from different misters. You finish each other’s sentences. The last time you disagreed with each other was when you each thought the other was the best person ever.

Time flows on. People change. The Steves of Apple went their separate ways. So did Microsoft’s Gates and Allen. Even the Beatles decided they couldn’t stay together. Reasonable people take different routes. When there is an even split among the directors, the company freezes and begins to die a most unnatural death.

Instead, have a third director from outside the company – a veteran of the industry who is respected by both parties. The third director can leave the other two to work things out, except when there is a divergence of opinion. Then the third can act as mediator, or at worst case, arbitrator.

 

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