Thursday, February 2, 2017

How to Form a Delaware Corporation (Correctly)

Forming a Delaware corporation is pretty straightforward for those who have done it many times before.  You just have to follow the steps.  Skipping any of them may hurt the founders later on, when they find out that they are not actually the shareholders of their company.  These formation mistakes are typically revealed at the time when the company is undergoing a legal due diligence in advance of a financing event.  How embarrassing it is to have to deal with legal clean-up at that time!

So, I decided to write down the steps I take to ensure that my clients are properly set up from the get go:

Step 1.  Check name availability with the Delaware Division of Corporations.

Step 2.  (Optional but recommended if the company will be using its name as a trademark): Check whether the name is available as a trademark with the USPTO.  Several of my clients had to change their company's name because it was already used as a trademark by some other business.

Step 3.  Obtain a registered agent.  I typically choose Harvard Business Services.  They charge only $50 per year.

Step 4.  File Certificate of Incorporation with the Division of Corporations. Startups authorize anywhere between 5 million and 10 million shares of common stock.  That number has to be included in the Certificate of Incorporation.  It is signed by an Incorporator (usually, an attorney doing the filing).  Attorneys typically have their own forms of the Certificate that they prefer to work with.

Step 5.  Once the Certificate has been filed, prepare an Action of Incorporator, whereby the Incorporator (i) adopts the initial Bylaws, (ii) elects the initial Board of Directors, and (iii) resigns.  This is a simple but yet an important part of the formation process that often gets overlooked.

Step 6.  The initial directors adopt the corporation's initial written consent, whereby they, among other things, (i) elect the officers and (ii) authorize the issuance of stock to the founders.

Step 7.  The founders enter into Restricted Stock Purchase Agreements ("RSPA"s) with the company to purchase the shares at par value, the idea being that at the time of formation the value of the corporation equals to the par value of its shares.  The amounts that the founders have to pay for the shares are very small, less than $1,000 in total, but it is important to make sure the founders actually do give this money to the company and that money is deposited into the company's bank account and accounted for in the books.  The company then issues receipts for the money received from the founders.

Step 8.  If the founders' stock is subject to vesting, the founders must make Form 83(b) election with the IRS.  They only have 30 days to do so from the date of the RSPAs.  There are no extensions.  Failure to do so on time can result in very onerous tax consequences for the founders.

Step 9.  The founders enter into Technology Assignment Agreements with the company, dated as of the date of the RSPAs, transferring to the corporation all IP they have developed for the company prior to its formation.  This is also a very important step.

Step 10.  One final agreement.  At the same time as the RSPAs and the Technology Assignment Agreements, the founders sign Confidentiality and Invention Assignment Agreements that say that all IP that they develop on behalf of the company going forward belongs to the company.  There can be exceptions.  For example, all inventions that do not relate to the company's business, that have been developed not using the company's facilities or equipment during off work hours belong to the employees individually, and not to the company.  This is the case for all companies located in California (even if they are DE corporations), and this exception is widely used in other states as well.

Step 11.  Get the EIN.  This can be done by completing form SS-4 and/or obtaining the EIN online.

Step 12.  Open a bank account.

Step 13.  Qualify the company to do business in the home state (assuming it is actually not located in Delaware).

This in my view completes the incorporation process.  If you have any questions, let me know.

This article is not legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

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