Business Attorney Tips: Forming a Corporation to Organize Your Business

Even in an age in which so many new companies have the letters “LLC” after their names, corporations still play an important role. Structuring your business as a corporation has advantages and disadvantages. Your Massachusetts business lawyer can help.

Background:

  • A corporation is a created by filing a document with the state in which it is organized that meets specified statutory requirements. The name of this filing varies depending on the state and type of corporation. For instance, it is a Certificate of Incorporation for a Delaware business corporation, but Articles of Organization for a Massachusetts not-for-profit corporation.
  • If most of its business and investors will be local, it is often less expensive to file in the state in which it is located. However, if it will have institutional investors or investors who are not local, it may make sense to incur the extra cost to incorporate in Delaware.
  • Different states use the terms “shareholder” or “stockholder” for owners. For instance, Delaware corporations have stockholders, while Massachusetts corporations have shareholders.
  • Corporations are often simpler and less expensive to set up than other kinds of entities.

Liability and Operations:

  • The liability of the shareholders is typically limited to the amount they invested in the corporation, except for certain taxes and sometimes wages. While there is a legal doctrine called “piercing the corporate veil” that allows general business creditors to go after individual shareholders, the law sets a very high bar for this kind of suit.
  • Management is straightforward. The CEO runs the company, subject to the oversight and direction of the board of directors. All other employees report directly or indirectly to the CEO (or president, depending on how it is set up). The Board is not involved in day-to-day management of business corporations.
  • Corporations have the flexibility to create different classes of stock, with different voting rights and different rights to receive dividends and distributions.
  • The owners of a corporation can enter into a shareholders agreement that requires them to vote for certain directors and places restrictions on transfer of shares (including so-called “buy-sell agreements”), leading to more certainty in the management and ownership of the business. The forms provided by on-line services often do not reflect what the business owners would intend if they were writing the agreement from scratch.

Taxes

The choice of entity is often driven by the tax treatment.

  • Corporations are taxed on their income. In order for investors to get money out of a corporation, either (i) the investors must be paid as employees or independent contractors of the business or (ii) the corporation must declare dividends. Dividends are typically taxable, creating a so-called double layer of taxation. In other words, the tax treatment often makes corporations more expensive than other types of entity.
  • If the ownership and structure of a corporation meets certain guidelines, the owners can file with the IRS to create something called an “S corporation” (a regular corporation is a “C corporation”). An S corporation is taxed like a partnership, with only one layer of taxation – that is, for tax purposes it is as if the individual owners earned income and generated losses directly.
  • It can sometimes be difficult to have as much flexibility as a partnership or limited liability company with regard to how cash is distributed and, in the case of an S corporation, how income and losses are allocated for tax purposes.
  • For non-US shareholders seeking to avoid income that is “effectively connected to a trade or business” in the US for tax purposes, operating a business through a C corporation is often the best option.

A Massachusetts business lawyer can help guide you through the process for deciding on choice of entity as well as other matters that arise when you are starting a new business.

Three Questions to Ask Your Potential Business Lawyer

Lawyer And Client Are Handshaking After Successful MeetingBefore hiring a Massachusetts business lawyer, you should feel confident that he or she is the right person to help you with general advice or with your specific issue. Here are the three questions to ask your potential attorney:

What Is Your Experience in This Industry?

Many industries develop specific terminology and ways of doing business. Some particular business issues, like certain kinds of contracts, might require special expertise or knowledge. While many business lawyers can draft and negotiate most kinds of contract and can negotiate a resolution of most kinds of dispute, background knowledge can sometimes be helpful. On the other hand, a lawyer looking in from outside an industry may be able to bring a fresh insight to your situation.

Who Else Will Be Working on My Case?

Some attorneys work in large offices, with teams of associates, paralegals, administrators and other support staff. Others are in smaller offices and call on teams of people within their networks as needed for particular projects. You should be aware of how your attorney works at the outset. It is best to find out up front what the terms of communication are and who you can expect to work with so are not surprised down the road. It is also best not to be surprised by bills that list hours of time from people you have never spoken with, unless your understanding is that a single attorney will be the main point of contact for the team.

How Do You Bill?

Just like your understanding of the communication guidelines, you should be informed about how billing will work. Many attorneys bill hourly but might require a retainer up front. Others bill flat fees for particular project, and still others bill contingent fees depending on the outcome of the project. Be sure your attorney has an understanding about the scope of your case so he or she can give you an understanding of the scope of the charges. Also be sure you are kept up to date on how charges are accruing. Setting these expectations early minimizes the chances of your being put in a payment bind you were not expecting.

Should We Have a Business Lawyer Draft Our Buy-Sell?

Business lawyer in MassachusettsThe buy-sell agreement is one of the cornerstones of most businesses, laying out how the future will unfold in the event of “triggering” factors like death, disability, divorce, and departure from the company. Corporations that have more than one shareholder should seriously consider a buy-sell agreement, but it is not a good idea to use a generic form or to create one yourself without an attorney’s insight.

Businesses can be complex, and the different interests that shareholders bring to the table are usually what prompt a buy-sell agreement to begin with. Since one shareholder’s leaving the company for any reason can have such serious implications for everyone involved as well as the business itself, it is important that the document be accurate and reflect what the stakeholders actually believe it reflects. Small mistakes can wind up costing shareholders in big ways. For instance, what are the triggers? Who gets to buy the shares, and in what order? How is the buyout funded? Does the affected shareholder have to sell?

This is why having the document prepared or reviewed by a business lawyer in Massachusetts is so important. The document can be reviewed for alignment with local and state laws and be explored in detail to ensure that it will be valid in the future. Most importantly, the lawyer can advise you on common pitfalls and provisions that most people choose to include. Having a business lawyer in Massachusetts draft and review the document can be critical for reducing the opportunities for litigation or confusion in the future when a triggering event happens. Having a proper buy-sell agreement in place can both minimize problems and provide for a smooth transition when one party or more departs the company