Saturday, November 30, 2019

Corporate Formalities for Delaware Startups

You have just formed your very first Delaware corporation. Congratulations! Although as a busy founder you may not have time to take care of ongoing corporate maintenance, there are some minimum corporate formalities that you should strive to maintain.  Below is my list and the reasons why.

One of the main benefits that is afforded by corporate structure is the limited liability protection for its owners. This means that the corporation and its stockholders are treated as separate legal entities. The corporation enters into its own contracts, and therefore, it is only the corporation’s assets, and not the assets of its individual stockholders, that are available to pay for judgments and claims of creditors.

There are, however, circumstances when a creditor of a corporation can “pierce the corporate veil” to hold the corporation’s stockholders liable for the corporation’s debts and other obligations. When deciding whether to pierce the corporate veil and hold stockholders personally liable, courts consider, among other factors, whether:
  • the corporate formalities have been disregarded;
  • the corporation is a mere fa├žade of its owners; 
  • the corporation is inadequately capitalized; 
  • the owners use the corporation’s assets and property as their own; 
  • the corporation makes undocumented “loans” to the owners or extends credit not on market terms; or 
  • the owners simply take money out of the corporation; 
The following best practices with respect to corporate governance and external appearance of the corporation may strengthen the argument that the corporation exists as a separate legal entity:

Stockholder and Board of Directors Meetings. The corporation should hold both annual stockholder and Board meetings (or at least prepare unanimous written consents). In addition, the Board should consider and approve all significant actions of the corporation (such as taking out loans, hiring executive officers, selling securities, entering into any other transaction that is out of the ordinary for such corporation). A majority of disinterested directors or the stockholders should approve all transactions between directors, officers, and the corporation.

Delaware Annual Report and Franchise Tax. In order to maintain good standing in Delaware, the corporation has to file an online annual report with the Delaware Division of Corporations and pay the Delaware franchise tax no later than March 1st of each year.

Delaware Registered Agent. It is important to renew the services of the mandatory Delaware Registered Agent every year.  The fee is about $50/year.

Qualifying to Do Business in the Other States. If the corporation is conducting business in another state, it must register there as a foreign corporation and pay tax on the income derived from that state. The definition of “conducting business” varies state by state. So, please reach out to your accountant or lawyer for assistance with this question.

Separate Bank Account. The corporation must have its own corporate bank account. All expenses must be paid from that account and all revenue be deposited there. If the founders paid for incorporation expenses personally, they should submit an expense report and be reimbursed by the corporation from the corporate bank account. One of the “red flags” for the “piercing of the corporate veil” argument is the co-mingling of funds between the corporation and its owners.

Hiring Employees. The hiring process is complicated and involves setting up payroll, preparing pay notices, registering with appropriate state authorities, complying with federal immigration laws, and obtaining the mandatory insurance policies. Failure to comply with these requirements may result in hefty fines.

Debt Guarantees. Stockholders should be careful not to personally guarantee and pay debts of the corporation (at least not on the recurrent basis). Otherwise, the courts may decide that the owners act as “alter egos” of the corporation and the corporation has lost its separate entity status. Board resolutions should be adopted allowing guarantees for specified purposes only.

Acting on Behalf of the Corporation. All documents signed on behalf of the corporation must indicate the signing officer’s name and title. For example:

XYZ Inc.

________________
Name: John Smith
Title: CEO

Further, all contracts should be in the name of the corporation, and the insurance policies should name the corporation as the insured. The full corporate name should appear on the website, business cards, letterhead, and checks of the corporation. 

In conclusion, although this list seems long, it actually doesn't take much effort to comply with if the proper procedures have already been set up.  Your accounting and legal team should work with you on ensuring that your startup follows all corporate formalities.

This article is not legal advice and was written for general informational purposes only.  It does not express anyone else's views except for the author's.  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.  

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