Having a good legal foundation is a crucial part to starting your business. The 3 key components are:
Entity choice
Filing with Secretary of State
Founding documents
Which entity should I choose to form my business?
There are several business structures you can choose to form your business. There are sole proprietors, partnerships, Limited Liability Company, S-corporation, and Corporations. Its very important that you choose the right entity for your business. Each entity offers a variety of options and choosing the wrong one can lead to unforeseen consequences later down the road such as negative tax implications or your ability to raise capital. Two weeks ago in a blog post I went into further details of each entity choice and their tax implications. Check it out if you need more information.
What forms do I file with the Secretary of State?
The entity choice will determine which forms you will file with the state. For example, in North Carolina if you choose LLC as your entity you will have to file Article of Organization with the Secretary of State along with the required fee; which is $125. For a corporation you will file Articles of Incorporation with the Secretary of State along with the $125 filing fee. Make sure to check with your Secretary of State to determine what documents needs to filed. Once you file the articles in North Carolina, within 2-3 weeks you will receive notice from the Secretary of State. Its importation to wait until you receive notice before beginning operation in order to receive the protections under your entity structure. Click here to visit NC Secretary of State website to view the different forms to file.
What legal documents are needed to start a company?
Each entity choice has a standard set of formation documents. For example, an LLC should have an operating agreement. In North Carolina, it is not required to have a operating agreement to form a LLC but it is important to have one, even if you're a single member LLC. However, some states like New York or California require an operating agreement for an LLC. An operating agreement is the blueprint for your business. It establishes the various policies, procedures, member duties and responsibilities, such as how you will fund your business, pay yourself or other member, or who can view records. Operating agreements outlines how the business will run, which is fundamental in a business in case of death, disability, or disagreements among the members. If there is no operating agreement in place the business has no guidelines or requirements for handling major issues or changes. In addition, an operating agreement helps to maintain liability protection offered under LLC’s because it shows the business is a separate entity from your personal assets.
Another important reason to have an operating agreement is because if you don't your business will be subject to your state default rules. Meaning each state has some sort of Limited Liability Act that governs the membership and management of an LLC in that state. Here in North Carolina, it is the North Carolina Limited Liability Company Act under Chapter 57D of the North Carolina General Statute. A business can elect to have their own operating agreement that outlines membership and management but if they do not the Limited Liability Act of your state will control. Let me give a simple example how this would work in real life. Lets say you have a multi-member LLC consisting of 3 members. Member A contributed 80%, Member B contributed 10%, and Member C contributed 10% of capital to start the company. There is a vote that needs to place on an important decision about the company. The company has no operating agreement in place. Member B and C are voting no on the decision and they are the minority members because collectively own 20% interest. Member A votes yes for the decision as a majority member because he owns 80% interest. Under the NC Limited Liability Company Act, each member is given one vote regardless of their ownership interest and the majority vote wins. Therefore member B and C voting no and are minority members would control the decision making of the company because they have the majority vote 2 out of 3. However, if there is an operating agreement in place it can supersede the default rule and have voting rights equal to your ownership in the company. It would be wise for a majority member to have an operating agreement in place in this scenario. This is just one scenario of how not having a operating agreement can affect your business, there are so many others ways that it can.
LLC's are not the only business entities that have founding documents. Corporations have bylaws which are very similar to operating agreements. Bylaws are basically the rules of the corporation. Partnership will have partnership agreements which sets out the terms of the partnership and the nature of the business. Whatever entity you choose to form make sure you have the proper documents in place to protect yourself and your business.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstances or fact situation. no action should be taken in reliance upon the information in this article without first obtaining the advice of an attorney.
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