I don't think incorporation was the mistake here, but rather incorporating with no help and without knowing what you're really doing is. I recently incorporated using harvard business services, for $300 I had everything taken care of for me and had all the paperwork in 2 days, well worth the money.
Totally agree. It would be unfortunate if anyone takes away from this that incorporating is a bad idea. What is a bad idea is incorporating with no idea of what you're doing. I disagree that this is a story of dissolution. It is a story of having incorporated with no understanding of the consequences, and finding out too late that he should have sought legal advice to begin with.
There is a lot of talk online about Delaware being the best state for incorporation. This is true if you are seeking outside financing, and most angels/VC's want to see a Delaware C Corp prior to investing. However, if you are going to raise investment, you need to have a lawyer anyway. So at the point you take investment, your lawyer can handle doing an incorporation in Delaware. No one should be filing for C-corporation status by themselves, with no background in the legal requirements.
In the meantime, if you are a startup who wants to put out a product for public use, or need to bring aboard paying customers of any kind, you should probably have an LLC. These are relatively cheap to create (and dissolve) and you can generally find law firms who will do pro bono work for startups in filing the appropriate paperwork (I have found several). Even LLCs require operating agreements and other paperwork before they are considered true legal entities. Any decent law firm does this all the time, and has the appropriate documents on file. Doing this yourself is again asking for trouble. For example, if you do business on behalf of your LLC as the "CEO", "President", or "General Manager", and have not specified that title in an operating agreement, you may be at risk of having the veil pierced (http://en.wikipedia.org/wiki/Piercing_the_corporate_veil), because you are transacting business on behalf of the company in a role that does not legally exist.
In most states, if you have an owner run LLC, your official title is "Member". However, most people don't want to represent their company as "Member", as this sounds weird, and is not a commonly used term. So in practice, you call yourself something else, like General Manager. If your operating agreement says that you can run the company under the title of "General Manager", or anything else you want to call yourself, then you are totally cool. If not, then you will be in trouble if a customer ever takes you to court.
Can you post some cases or background regarding piercing the corporate veil for an LLC based on "transacting business on behalf of the company in a role that does not legally exist"? Who is to say what does or doesn't exit? Based on this logic, a large LLC or LLP would be required to have its whole hierarchy listed in the operating agreement.
"The main reason to make an operating agreement is to help ensure that courts will respect your limited personal liability. This is particularly key in a one-person LLC where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship. Having a formal written operating agreement will lend credibility to your LLC's separate existence."
The operating agreement usually specifies that the member can operate all aspects of the business, including hiring, firing, etc. So authority flows from the member in terms of other people's titles, and it is not necessary to specify lower level employee's title in the operating agreement. It is, however, necessary to specify the relationship of each owner in an LLC to the business if they will be transacting business on behalf of the company. This ensures that the veil between personal and company property remains intact.
Bad news: there aren't any landmark cases. The area is so new that most states haven't even had this issue come up in court yet.
However, I can tell you that the general consensus is that LLCs borrow from corporate law where piercing the veil is concerned.
Veil-piercing isn't about "transacting business on behalf of the company in a role that doesn't legally exist." That's an indemnity issue (the LLC is trying to shuffle blame from itself to an employee).
Veil-piercing is about going after the owners of a company on the grounds that the company is really just an extension of the owners' will and bank accounts.
Key factors for veil-piercing (for an LLC):
- Owners use the LLC funds for personal expenses without reimbursing the LLC.
- Zero/below-market loans from the LLC to the owners.
- LLC business decisions made to benefit the owners rather than the business.
- Undercapitalization (LLC not have enough money to pay its bills/expenses/liabilities without the owners covering some of these expenses).
There are more, but those are the big ones. The piggy-bank, low-interest-loan, and undercapitalization factors are usually the most important.
"Veil-piercing isn't about "transacting business on behalf of the company in a role that doesn't legally exist." That's an indemnity issue (the LLC is trying to shuffle blame from itself to an employee)."
No... you are confusing the issue.
By way of example, let's say that I am running a member (owner) managed LLC. My official title under state law is "Member". But I sign all my documents with customers and suppliers as "CEO". Then, the company goes broke, and owes money to its suppliers. The suppliers could argue that I did not represent the company in good faith, because I was not the CEO of the company. That position doesn't exist. So they might want to come after me personally instead. Depending on the laws of your state, the court may agree that you did not represent the company in good faith, and allow your suppliers to pierce the veil and come after your personal assets.
The only way to shift blame to an employee would be in cases of fraud or gross negligence, and even then, your company would probably still be liable. What I am discussing is only really relevant in cases where the owner and manager are one and the same (as in the case of the original poster's situation). This doesn't apply to employees who may sign on behalf of the company for routine transactions, but don't have any controlling interest in the company. However, as a manager, it is best to make sure that anyone with signatory authority in your company is given such authority in the operating agreement. However, there is no such thing as piercing the veil with regards to an employee of a company who does not have a substantial ownership stake. They will always come after the owners of the company if it seems that the company is a sham to protect personal assets. The more loosely you operate your company without specific legal agreements (ie operating agreement), the more likely someone will be able to prove that the company is a sham.
I read both this article and his previous of where he created a company with 10,000,000 shares initially. This is why it cost him so much to dissolve the company. If he knew what he was doing he would have created far less shares, like 1500 total.
I've learned that 10,000,000 shares is fine if you have a low par-value per stock. I believe this many stocks are especially good if you're looking for outside investors/board members.
But actually, don't listen to me, I'm the one whose in this ridiculous mess.
How stupid this was is dependent on the specifics, which we don't really have. Were you on the brink of raising a round of capital? Or did you just incorporate in anticipation of raising a round later?
A C-corporation in Delaware is considered the best entity for raising outside investment. The State of Delaware knows this, and charges hefty fees for maintaining a C-Corporation, and apparently for dissolving one. So it makes very little sense to incorporate in Delaware unless you will be raising an outside round of capital, because the costs of maintaining the C-Corporation itself are very high for a start-up with no money. Recognize that a "do-it-yourself attitude" is awesome for developing start-ups. It is perhaps one of the worst attitudes to take in terms of corporate entity formation and maintenance. Documents on file with a law firm with appropriate date and timestamps are virtually bulletproof in court. This is one of the many reasons law firms exist. Documents pulled out of your filing cabinet, to which only you have been privy until the time they end up in court, are a bad, bad idea. Bootstrapping your legal documents or anything else having to do with your corporate entity is a flat out terrible idea, unless you basically do this for a living (in some cases, there are startups who create LLC's daily, in which case you presumably know all of this already).
