First in a Series of Three Articles
Americans have been forming businesses at record high rates since 2020, and this trend has continued through 2023. According to analysis published by the Economic Innovation Group, during the first two quarters of 2023, nearly 2.7 million applications for business formation were filed across the country, representing a 5% increase from 2022 and a 52% increase from 2019. When we counsel clients who are forming a new business, they often have a clear idea of the goals for the new business but are less certain about the business entity (e.g., corporation, a limited liability company (LLC), limited partnership (LP)) that is best suited to the business.
The following is the first in a series of three articles on business formation and how different business entities are formed and the goals they are best suited to achieve.
Why Form a Corporation?
One the primary reasons that clients form business entities is to limit the liability of owners for the actions of the entity. However, in most cases, an LLC or LP can limit owners’ liability in the same manner as a corporation, and, in addition, provide owners with more flexibility in structuring their businesses than a corporation. So why choose to form a corporation?
A corporation may be preferrable to other types of business entities if a client’s business goals include attracting investors. The corporate structure is less flexible than that of an LLC or LP, and this lack of flexibility provides clarity with respect to how decisions are made and stability with respect to management and operations, two qualities that are important to outside investors. A corporation may also be the preferred choice when a business intends to attract talent by offering employee benefits such as incentive stock options, as this type of compensation cannot be offered by an LLC or LP.
Roles in the Corporation
A shareholder is a person who owns shares of a corporation’s stock. A shareholder is entitled to vote on corporate matters on which shareholders are required or permitted to vote. A primary function of shareholders is voting to appoint a corporation’s board of directors.
The board of directors is appointed by the shareholders and is responsible for making high-level strategic decisions, providing governance and financial oversight, as well as hiring and supervising officers of the corporation. The board of directors is required by law to act in the best interests of the corporation and its shareholders.
Officers are hired by the board of directors and are charged with managing the corporation’s day-to-day operations and carrying out the strategies developed by the board of directors. Familiar officer roles include Chief Executive Officer (CEO), Chief Financial Officer (CFO) and General Counsel.
An individual can serve multiple roles within the same corporation. It is not uncommon for the directors, officers and shareholders of smaller corporations to be the same. One benefit to having a smaller group of corporate operatives is the ease of governance and decision-making within the formal structure.
How is a Corporation Formed?
A corporation is formed by the filing of a formation document with the government of the state in which the corporation will be formed. In the Commonwealth of Massachusetts, the formation document is known as the “Articles of Organization”. The name of this document varies across states.
At a minimum, the Articles of Organization for a Massachusetts corporation must include the following:
- Name of the corporation
- Business purpose
- Number and par value of shares
- Name and address of the registered agent
- Address of the principal office
- Names and addresses of the corporate officers and directors
- Fiscal year end
Requirements: Observing Formalities Upon Formation
To maintain limited liability for shareholders and organize the internal corporate structure, a new corporation must observe certain formalities. The corporation must adopt Bylaws to provide internal governance, appoint a Board of Directors to make high-level decisions and establish preferences, if any, for authorized shares of stock.
The Board of Directors must act, either by meeting in person or through written consent, to ratify the initial actions of the corporation, appoint corporate officers and to approve administrative actions necessary to establish the business of the corporation. The contents of this meeting, and all future meetings, should be signed by directors and maintained with the corporation’s internal records.
Though not required by statute, shareholders of a corporation may also consider establishing a shareholder agreement to formalize understandings of specific rights and obligations not typically included in the Articles of Organization or Bylaws, like restricting to whom a shareholder may transfer his or her shares or the right to appoint individuals to the board of directors.
For more information about business formation and evaluating what entity type may best serve your business, contact our attorneys in the Business Law practice at Wilchins Cosentino & Novins. Our business attorneys have decades of experience and offer skilled counsel to guide and assist you and your business throughout its lifecycle, from formation through succession planning.
This article is not legal advice and should not be taken as such or relied upon as legal advice.