How to Form a Corporation and Follow Governance RequirementsBy Deborah Sweeney
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A simple search of "governance documents" on Google will result in various corporations with multitudes of different documents (e.g., "Certification of Incorporation," "Code of Ethics," "Audit Committee Charter"). For a young entrepreneur looking to form a corporation, these documents may seem overwhelming and may discourage a potential business from incorporating. The reality, however, is that the vast majority of corporations do not need most of these documents.
It only gets complicated when a corporation becomes "large" where federal regulations begin to take effect. A simple way to know if your corporation is "large" is if your corporation is being publicly traded (listed on a Stock Exchange or sold on an OTC market). As mentioned above, most corporations are closely-held (not publicly sold) and state law tends to have relaxed requirements to form a corporation to spur more business within the state. For almost every conceivable situation, a corporation will begin as a closely-held corporation.
Required vs. Needed
Before moving forward with the governance documents for an LLC, a distinction must be made between "required" governance document and "needed" governance documents. The "required" governance document entails the document that LLCs must have as mandated by state law. Without this document, the state may not recognize a business as an LLC. The "needed" governance document is not mandated by state law, but it is a document that every LLC should have to prevent future complications and possibly catastrophic lawsuits. Also to note, LLCs are generally required to file an annual (or biennial) report with the state. However, this article will not be addressing these reports.
Required Governance Document - Certificate of Incorporation
Every corporation requires a Certificate of Incorporation. The Certificate is essentially the corporation's birth certificate and used as proof of a corporation's existence within a state. The Certificate is issued by the state and requires a potential corporation to file its Articles of Incorporation with the state (accompanied with the necessary state fees).
The Articles of Incorporation sets forth the basic information of your business. Generally, states have minimal requirements for the Articles: (1) corporation's name; (2) corporation's purpose ("to engage in any lawful activity"); (3) name and address of your corporation's registered agent (the entity who is authorized on the corporation's behalf to accept delivery of certain legal documents); and (4) stock information (number of shares the corporation is authorized to issue, designation of classes of shares, and possibly the initial value of each share). Beyond these minimal requirements, the Articles will usually identify the incorporators of the corporation (the person responsible for signing and filing the Articles). The Articles may also supply the number of directors and the names of the first directors.
Most, if not all, states have a standard Articles of Incorporation form that outlines the minimal requirements for the state. An applicant can simply fill in the blanks, sign, and file that form to be incorporated. However, depending upon the complexities of your corporation (e.g., different class shares, particular election of directors, membership qualifications, indemnification provisions), the Articles may include these complexities, but the corporation can elect to include these special provisions within the Bylaws (see below). A professional should be consulted when considering these special provisions. The Certificate must be kept with the registered agent.
Needed Governance Document - Bylaws
States do not require LLCs to file an operating agreement. In fact, a number of states do not even require the operating agreement to be in writing to be enforceable. However, the operating agreement may prove to be the most important governance document an LLC can have and so every LLC should have a written operating agreement. Due to the relaxed requirements for the Articles of Organization, some of the most important governing aspects of an LLC are left unwritten. Similar to the bylaws of a corporation, the operating agreement fills in these blanks.
The bylaws generally describe the functions of each corporate office, how shareholders' and directors' meetings are called and conducted, the formalities of shareholder voting, the qualifications of directors, the functions of board committees, and procedures for and limits on issuing and transferring shares. These provisions give structure on how the corporation is governed. Many bylaws contain indemnification provisions that may protect the directors, the officers, or both, as well as a severability clause that allows the bylaws to survive and be enforced even if a particular provision is held to be invalid. The bylaws must be consistent with the Articles of Incorporation and if any discrepancy arises, the Articles hold precedence. The bylaws can be amended as needed and the bylaws should specify the procedures for amendment.
Needed Governance Document - Minutes of Meetings
Every corporation is required to have annual meetings for both shareholders and directors. A corporation can also call special meetings for shareholders and directors. The activity that occurs during these meetings is recorded within the meeting's minutes. The minutes are used as the official record for these meetings. Although the minutes are an important part to the governance of a corporation, minutes should remain light. Only information of substance should be included, while extensive details on what was presented excluded. For more information on the meeting minutes, please refer to the comment of meeting minutes.
For many corporations, the only governing board they will have (or need) is the Board of Directors. However, larger corporations may have specialized governing needs (i.e. litigation and audit committees). Often these needs are federally mandated and so the board may formulate a committee of inside and outside directors to govern these committees. As a consequence, the corporation will create committee charters that in essence act as the committee's bylaws.
Code of Ethics/Conduct
Beyond the governance documents listed above, the corporation may also communicate the expectations it has from the governing bodies (directors and officers) and from its employees. These expectations are generally spelled out in a code of ethics (the expectations shareholders have upon the corporation and its governing body) and in a code of conduct (the expectations the corporation has upon the employees). These documents are not necessary for smaller corporations (where the shareholders, directors, and officers are the same people). However, for larger corporations with many independent employees and many independent shareholders, these codes become important.
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