Many online service providers exist to help founders incorporate quickly and at a low cost. They typically use standard templates to make government filings and set up internal corporate documents. While these templates work great for startups with a simple structure and management team, they can be insufficient to cover the legal issues that frequently arise for founders. Here, we’ll go over some of the essential documents of incorporation that online service providers may miss.
Organizational Resolutions
Most founders know what bylaws are, but organizational resolutions remain more of a mystery. If we use the analogy of the political structure of a country, then bylaws are the constitution or foundational laws, while organizational resolutions are documents that appoint the president and other politicians and stakeholders. Bylaws set out the operating rules of a startup, such as the voting procedures, the rights of the shareholders, directors and officers, and the basic management mechanisms. Organizational resolutions appoint the management team of the startup, issue shares to certain initial shareholders, and set out other very specific matters relating to the structure of the startup.
Why are organizational resolutions important? Since they are fairly standard in format, they help founders save on legal costs. More specifically, if lawyers are involved at a later stage than incorporation to draft custom board resolutions and deal with tax issues relating to the issuance of shares, then the costs of setting up a startup could rise dramatically.
Shareholder Agreement
Shareholder agreements define the relationship between the shareholders of a startup. There are certain matters that founders should pay attention to early on in order to avoid potentially dramatic fights further down the road. One example is the procedure by which unhappy shareholders can follow to dump their shares and leave the startup. This sounds simple (they can just sell their shares and go), but there should be rules on pricing the shares, if the shares have to be offered to existing shareholders before they can be sold to third parties, or if any restrictions apply with respect to timing. Another example is whether minority shareholders should be allowed to prevent or lead key events of the startup, such as mergers, acquisitions, and IPOs. Shareholder agreements can also include clauses on vesting that prevent shareholders from accessing their allotted shares before the occurrence of certain milestones.
Even if things couldn’t be merrier at the moment, founders should anticipate the possibility of their relationship breaking down. If everyone is unprepared when this happens, then fights over the details of how someone is allowed to leave can cause the startup to fail. It’s better to have a shareholder agreement in place so that even if everyone is unhappy, there is at least some certainty in what to expect.
Certificate of Incorporation
Many founders skip reviewing the certificate of incorporation because they think that it just has to contain the most basic information about their startups. In reality, certificates of incorporation contain key information on the rights associated with each class of shares (such as voting rights), how the number of authorized shares can be changed, the indemnification of officers and directors, and other specific matters of startups that are “coded into their constitution.”
Online service providers use simple templates to file certificates of incorporation, which can work perfectly fine for startups that don’t require any customization as to their capitalization or operating structures. If, however, founders want additional tailoring, then they should review their certificates of incorporation prior to filing to ensure that all the necessary clauses are included. Filing amended and restated certificates of incorporation at a later stage can prove costly.
Strategic Importance of Early and Adaptable Incorporation for Startups
While it’s important for founders to have their incorporation documents in order early on, not getting all of the details in at the start isn’t the end of the world. There are always opportunities to amend or add documents; it’s just that doing so would lead to higher legal costs further down the road. With that said, circumstances in startups change quite rapidly and incorporation documents may need to be amended in any case. Founders should be strategic in defining the core structural elements of their startups and working them into organizational resolutions, shareholder agreements, and certificates of incorporation.
