Embry Riddle Aeronautical University Corporate Governance Pros and Cons Worksheet

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Embry Riddle Aeronautical University

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Corporate Governance

8.2 - Assignment: Corporate Organization

The Situation

A smiling woman with her arms folded.

You now understand Sally’s ambition, how she thinks, her quest for perfection, and her focused vision for future success. From your perspective, (1) what form of business do you believe is most suited for the immediate formation of the company, and if applicable, (2) do you perceive the need to change the original form you chose in your business plan to another form now or overtime? (3) Why, or why not? You have reviewed all aspects of becoming a legally recognized business. You understand the tax issues, the management structure options, raising operating capital, the various types of insurance coverage required, and the necessity of having the peace of mind in the event of a catastrophic moment. As a manager-owner, the concept of “piercing the corporate veil” gives you a sinking feeling when confronted with a questionable operating decision. (4) What steps can you take to avoid facing a situation that would cause a court to pierce the corporate veil of your business? You have a lot to debate in deciding the governance form Sally would prefer. (5) Would she prefer an LLC, S-Corp, or C-Corp, and why? (6) Discuss why you believe Sally would prefer one form of a company organization over another.

We know Sally successfully operated her own multimillion-dollar business, with sufficient business expertise without the benefit of a corporate board or shareholders. We know she fully funded her business and carries no debt that would impede this new venture. We know she has worked well with you as a team in the drive to start this enterprise. Carefully consider what form works best between the two of you in building this empire and why. What about the future? How do all the pieces fit looking forward? What topics must be included in the discussion before any expansion of the business takes place? Explain.

Helpful Documents

Sally has found several documents to help with picking which type of corporation to form for the business you are building with her. Feel free to use this information. She has shared them here:

Your Assignment

Create a matrix charting the pro and cons and advantages and disadvantages for the following forms of company organizations:

  • LLC
  • S-Corporation
  • C-Corporation
  1. Cost: what are the comparative costs of setting up?
  2. Ease: what are the relative costs for setting up each?
  3. Termination: what is the state requirement for continuity?
  4. Public Information: how important is it that your personal information is shared or not shared with the public
  5. Risk: what level of liability exists in the operation of the business based on the type of business itself what is the best form to insulate owners from personal liability
  6. Operation: what form best supports the intentions of the owners what is the best control risk balance form of operation
  7. Capitalization: is there a risk of undercapitalization what would be the impact will there be a need to raise capital to avoid increased liability is there a form that makes it easier to raise capital
  8. Selling: if owners wish to sell what form best accommodates that situation
  9. State Taxes: what are the tax liabilities from the state in setting up the business
  10. Expansion: which form provides the greatest flexibility in the event of expansion

Your table should look something like this Example Matrix:

Limited Liability Company (LLC)

S-Corporation

C-Corporation

Pros

Cons

Pros

Cons

Pros

Cons

Cost
Ease
Termination
Public Information
Risk
Operation
Capitalization
Selling
State Taxes
Expansion


Create your document in a .DOC, .DOCX or .RTF and upload it. Be sure to pay attention to formatting do the Pros and Cons for each cell.

https://www.sba.gov/business-guide/launch-your-bus...

https://www.irs.gov/businesses/small-businesses-self-employed/business-structures#:~:text=Your%20form%20of%20business%20determines,%2C%20corporation%2C%20and%20S%20corporation.




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Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) Choosing an Entity Comparison Chart by Practical Law Corporate & Securities Maintained • Delaware, USA (National/Federal) A comparison chart that highlights the various structure, liability, tax and management differences among C-corporations, S-corporations, limited liability companies, and partnerships. This chart focuses on the laws of Delaware business entities. Because different states have different laws concerning business entities, it is important to consult the appropriate state statutes before finalizing your choice of entity (see Corporation Law: State Q&A Tool). There are many different considerations when choosing the appropriate business entity. Which entity form you choose depends on what the intended purpose is for the entity (for example, to make an acquisition). The following table provides a comparison of the differences among the most common entities: C-corporations, S-corporations, limited liability companies, and limited partnerships. Use this table as a resource when deciding which entity to form. Since most LLCs are treated as partnerships or disregarded entities for tax purposes, this chart assumes that is the case. Type of Entity C-Corporation Ownership Requirements One or more stockholders. One to 100 stockholders. No restrictions on the types of owners. S-Corporation With certain limited exceptions, only US individuals (citizens or residents) can be stockholders. Certain trusts and exempt organizations can also be stockholders. Limited Liability Company (LLC) Limited Partnership (LP) One or more Two or more partners. members. Two or more members No restrictions on the types of owners. required if LLC wants to be taxed as a partnership. No restrictions on the types of owners. Only eligible US entities can make an S-corporation election (generally a US C-corporation or other US business entity eligible to elect C-corporation tax status). An S-corporation © 2019 Thomson Reuters. No claim to original U.S. Government Works. 1 Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) automatically converts to a C-corporation if it does not meet the requirements of an S-corporation (meaning, no more than 100 stockholders, only specific types of stockholders, and only one class of stock). Form of Equity and Restrictions Capital stock is held by one or more stockholders. There are two basic types of capital stock: common stock and preferred stock. Capital stock is held by one or more stockholders. Only one type of capital stock: common stock. Percentage of Two classes of partners: membership interests are held • A general partner by one or more (generally responsible members. for management). Only one class of stock is Permissible to have permitted, but there can be Permissible to • A limited partner multiple classes and series differences in voting rights classify (typically a silent of stock with different among shares of common membership investor). rights and preferences. stock. Certain debt interests into instruments as well as different classes • At least one general Distributions must be certain options, warrants, (like common and partner (who may or proportionate to stock or similar instruments may preferred stock) may not have made a ownership within each be treated as a second with different contribution) is class of stock (preferential class of stock under the rights and required to form an distributions permitted for S-corporation rules. preferences. LP. one class over another). Distributions must be Distributions do • Distributions do not proportionate to stock not need to be need to be ownership. proportionate to proportionate to LLC ownership. partnership Distribution, liquidation, and voting preferences can be specified in the limited liability company agreement. Organizational Documents Formation document: certificate of formation filed with the secretary of the state of formation. ownership. • The limited partnership agreement can specify distribution preferences. Formation document: certificate of incorporation filed with the secretary of the state of incorporation. Formation document: certificate of incorporation filed with the secretary of the state of incorporation. Governing document: by-laws (in addition to the certificate of incorporation). Stockholders may also enter into a stockholders’ agreement. Governing document: by-laws (in addition to the Governing document: limited certificate of incorporation). partnership agreement. Stockholders may also Governing enter into a stockholders’ document: limited agreement. liability company agreement. An eligible US entity makes a timely S-corporation election on IRS Form 2553, no more © 2019 Thomson Reuters. No claim to original U.S. Government Works. Formation document: certificate of limited partnership filed with the secretary of the state of formation. 2 Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) than two months and 15 days after the beginning of the tax year the election is to take effect. Levels of Tax and At the corporate and Other Tax stockholder level. Considerations Can participate in tax-free reorganizations under IRC Section 368. At the stockholder level only unless S- corporation was formerly a C-corporation. Some states do not recognize S-corporations for state tax purposes and instead tax them as C-corporations. At the member level only. Cannot participate in tax-free reorganizations under IRC Section 368. At the partner level only. Cannot participate in tax-free reorganizations under IRC Section 368. Can participate in tax-free reorganizations under IRC Section 368. Liability Stockholder’s liability is Stockholder’s liability is Member’s liability Limited partner’s liability is limited to amount of capital limited to amount of capital is limited to limited to amount of capital contributed. contributed. amount of capital contributed. contributed. General partner has unlimited liability. Management A C-corporation is governed by a board of directors. The board of directors must designate officers to manage the day-to-day operations. Certain major decisions need to be approved by the stockholders. An S-corporation is governed by a board of directors. The board of directors must designate officers to manage the day-to-day operations. Certain major decisions need to be approved by the stockholders. Management is initially vested in the members. Members can delegate management to a managing member, non-member manager, or The board of directors may The board of directors may board of delegate certain decision delegate certain decision managers. The making to committees. making to committees. manager(s) can (but do not need There is a well-developed There is a well-developed to) designate body of corporate case law body of corporate case law officers to and statutes which and statutes which manage provides greater certainty, provides greater certainty, day-to-day but less flexibility than but less flexibility than operations. other entity forms. other entity forms. Certain major decisions typically have to be approved by the members. Management is initially vested in the general partner(s). The general partner(s) may delegate management and may (but do not need to) designate officers to manage day-to-day operations. Certain major decisions typically have to be approved by the limited partners. The powers of the general partner can be limited by the limited partners in the limited partnership agreement. If limited partners participate in management, they risk losing the benefit of limited liability. The management structure is flexible and is primarily determined by the © 2019 Thomson Reuters. No claim to original U.S. Government Works. 3 Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) members and set out in the limited liability company agreement. Employee Incentive Considerations Stock options can be granted to employees (can qualify as incentive stock options (ISOs) under the IRC). Stock options can be granted to employees (can qualify as incentive stock options (ISOs) under the IRC). Other common forms of equity compensation include: Other common forms of equity compensation include: • Stock appreciation rights (SARs). • Stock appreciation rights (SARs). • Restricted stock. • Restricted stock. • Restricted stock units (RSUs). • Restricted stock units (RSUs). • Performance awards. • Performance awards. Profits interests or non-qualified options (to acquire a membership interest) can be granted to employees. ISOs are not available. Profits interests provide favorable tax treatment to employees and are much more common than options. Both profits interests and options to acquire a membership interest are less familiar than traditional stock options and may result in an employee being treated as a partner for tax and employee benefit purposes. Profits interests or non-qualified options (to acquire a partnership interest) can be granted to employees. ISOs are not available. Profits interests provide favorable tax treatment to employees and are much more common than options. Both profits interests and options to acquire a partnership interest are less familiar than traditional stock options and may result in an employee being treated as a partner for tax and employee benefit purposes. Other equity compensation arrangements (such as RSUs) can be replicated in the partnership context but are uncommon. Other equity compensation arrangements (such as RSUs) can be replicated in the LLC context but are uncommon. Capital Raising Considerations C-corporations raise capital through the issuance of equity (stock) and the incurrence of debt. Stock can be issued by private placements or if the C-corporation is public, by a public offering with stock that is registered with the SEC and listed on a public S-corporations raise capital through the issuance of equity (stock) and the incurrence of debt. LLCs raise capital through the issuance of equity (membership interests) and the incurrence of debt. Membership interests are typically issued in private LPs raise capital through the issuance of equity (partnership interests) and the incurrence of debt. Partnership interests are typically issued in private placements. LPs are not limited by a preset number of authorized interests, but may be restricted from © 2019 Thomson Reuters. No claim to original U.S. Government Works. 4 An S-corporation must be converted to a C-corporation before an initial public offering. It is easier for an Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) stock exchange. There is a lot of flexibility in the type of stock (for example, common, preferred, convertible debt, phantom) that can be issued, but the C-corporation is limited by the number of shares authorized in its certificate of incorporation (usually a very large number). The number of shares authorized can be increased by amending the certificate of incorporation which requires stockholder approval. The C-corporation may also be restricted from diluting its current stockholders by the terms of a stockholders’ agreement. If the corporation has current holders of preferred stock, they may also have anti-dilution protection. The terms of the preferred stock are typically set out in a certificate of designation. A C-corporation is the most common entity form for a public company. LLCs and LPs are typically converted to C-corporations before an initial public offering. An S-corporation must be converted to a C-corporation before an initial public offering. S-corporation to convert to a C-corporation than it is for an LLC or LP to convert to a C-corporation because an S-corporation automatically converts to a C-corporation if it does not meet the requirements of an S-corporation. placements. Members can create membership interests that mirror the properties of different types of stock. LLCs are not limited by a preset number of authorized interests, but may be restricted from diluting its current members by provisions in the limited liability company agreement. Except in certain industries (such as energy), LLC’s are not typically publicly traded. Often the members convert the LLC to a corporation before an initial public offering. If an LLC is publicly traded (called a PTP), it generally will be treated and taxed like a corporation under the IRC unless 90% or more of the LLC’s gross income consists of qualifying passive income (such as dividends, interest, real property rents, natural resource income, certain commodities income, and gains from assets that produce passive income) (see IRC § 7704). If an LLC is © 2019 Thomson Reuters. No claim to original U.S. Government Works. diluting its current partners by provisions in the limited partnership agreement. Because limited partners are prohibited from managing the partnership, it is a good vehicle when raising capital with silent investors. Except in certain industries (such as energy), LPs are not typically publicly traded. Often the partners convert the LP to a corporation before an initial public offering. If an LP is publicly traded (called a PTP), it generally will be treated and taxed like a corporation under the IRC unless 90% or more of the LP’s gross income consists of qualifying passive income (such as dividends, interest, real property rents, natural resource income, certain commodities income, and gains from assets that produce passive income) (see IRC § 7704). If an LP is publicly traded, units of LP interests (instead of shares of stock) are bought and sold. 5 Massie, Raymond 6/7/2019 For Educational Use Only Choosing an Entity Comparison Chart, Practical Law Checklist 7-381-0701 (2019) publicly traded, units of membership interests (instead of shares of stock) are bought and sold. Other Considerations Regulators and employees There are more limitations are most familiar with this on the availability of the form. S-corporation election than the C-corporation election More regulated than LLCs (only US entities can make or LPs. the election, no more than 100 stockholders, only specific types of stockholders, and only one class of stock). More regulated than LLCs or LPs. Statutory and case law is less developed than corporation and LP law. This provides more freedom, but less certainty. LPs (like LLCs) are subject to fewer formalities than corporations. Partnership law is more developed than LLC law. Regulators and employees are least familiar with this form. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 6 Massie, Raymond 6/7/2019 For Educational Use Only Forming a Corporation Checklist, Practical Law Checklist 1-381-0520 (2019) Forming a Corporation Checklist by Practical Law Corporate & Securities Maintained • USA (National/Federal) A checklist of the key steps involved and questions to consider when forming a corporation. Introduction This Checklist summarizes the main steps to take and key issues to consider when forming a corporation. While it covers the principal issues involved in forming a corporation, each state has its own statutory requirements that must be satisfied. for a more detailed discussion on this topic, see Practice Note, Forming and Organizing a Corporation). In addition, each corporation is formed for a different purpose and will have unique issues and circumstances (for example, the type of business the corporation will conduct and whether it plans to go public) that must be reviewed before forming the corporation. Incorporation Matters Select the Type of Entity • Is the client aware of the different types of entities and their features? • Is a corporation the best choice of entity based on commercial, legal, and tax perspectives? See Choosing an Entity Comparison Chart and Practice Note, Choice of Entity: Tax Issues. • Will the corporation be a C-corporation (the most common corporate form) or elect to be treated as an S-corporation for US federal income tax purposes? See Practice Notes, Forming and Organizing a Corporation and Choice of Entity: Tax Issues. • After selecting the type of entity, who will prepare the necessary IRS forms? Select the State of Incorporation • Delaware is a common state of incorporation. Is there a reason to form the corporation elsewhere? • Where will the principal place of business be located? • Will the corporation need to qualify to do business in other states? © 2019 Thomson Reuters. No claim to original U.S. Government Works. 1 Massie, Raymond 6/7/2019 For Educational Use Only Forming a Corporation Checklist, Practical Law Checklist 1-381-0520 (2019) • Are there special tax matters to consider? • Are there plans for the company to go public? See Practice Note, Forming and Organizing a Corporation: State of Incorporation. Choose a Company Name • Does the name satisfy statutory requirements in the state of incorporation? • Is the name available in the state of incorporation and any other states in which the corporation may qualify to do business? • If not incorporating immediately, consider reserving the name so it is available when the entity is ready to be formed. • Will the name serve as a domain name, trademark, or service mark? If so, consider running a separate search (such as a trademark search) to look for similar names in the marketplace. See Practice Note, Forming and Organizing a Corporation: Name of Corporation. Draft the Certificate of Incorporation • Does the certificate of incorporation satisfy statutory requirements in the state of incorporation? • Who will be the incorporator? • Consider the need to include optional provisions such as: • creation of different classes of stock; • staggered board of directors; • supermajority voting provisions; • pre-emptive rights; and • limitation of director liability. • Does the state of incorporation have any specific requirements regarding optional provisions? For example, some states automatically grant stockholders pre-emptive rights unless the certificate of incorporation specifically provides otherwise. • Will the corporation be public or remain private? • Has a registered agent been selected? The service company engaged to file the certificate of incorporation often acts as the registered agent for an additional fee. • What is the corporation’s registered address? File the Certificate of Incorporation • Will the certificate of incorporation be filed directly with the secretary of state or will a service company be used? • Is timing an issue? Counsel should be familiar with how long it takes to form a corporation in the target jurisdiction. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 2 Massie, Raymond 6/7/2019 For Educational Use Only Forming a Corporation Checklist, Practical Law Checklist 1-381-0520 (2019) • Does the state of incorporation accept copies of signatures or is an original document required? For instance, Delaware and New York accept fax signatures. • How will the filing and organizational fees be paid? Will the service company advance them (they typically do)? See Practice Note, Forming and Organizing a Corporation: File Certificate of Incorporation. Draft the By-Laws • Will the corporation be public or remain private? • Are the by-laws consistent with the provisions of the certificate of incorporation? For example, if the certificate of incorporation requires a super-majority to pass certain actions the by-laws should reflect this requirement. • Does the client have any concerns or objectives the by-laws should reflect? Draft the Statement (or Action) of the Incorporator • Did the incorporator adopt the by-laws? • Did the client decide who the initial directors will be? • Did the incorporator elect the initial board of directors? • Are there any other matters on which the incorporator should act? • Does counsel’s law firm have a policy for or against acting as the incorporator? Prepare the Initial Acts of the Board of Directors • Will there be a board meeting or will the board act by unanimous written consent? • Did the client decide who the initial officers will be? • Did the board authorize the typical organizational actions such as: • electing initial officers; • accepting subscriptions for and issuing stock; • applying for foreign qualification in other states; • approving the form of stock certificate (if applicable); • adopting the corporate seal; • adopting the fiscal year; • authorizing a stockholder’s agreement (if applicable); • opening bank accounts and authorizing signatories; and © 2019 Thomson Reuters. No claim to original U.S. Government Works. 3 Massie, Raymond 6/7/2019 For Educational Use Only Forming a Corporation Checklist, Practical Law Checklist 1-381-0520 (2019) • ratifying the acts of the incorporator? • Are there any other specific actions or documents the board should or needs to approve? • Is the corporation being formed for a specific reason or as part of a transaction such as a merger? If so, there may be deal-specific agreements and documents to approve. Issue Stock • Has a basic subscription agreement been prepared? • Has the stock certificate been filled out in accordance with the applicable statutory requirements? • Have all issuances been recorded in the stock ledger and are there copies of all stock certificates? • Have appropriate restrictive legends been included on the back of the stock certificates? Post-Incorporation Matters Prepare the Minute Book • Has counsel, the client, or the service agent ordered a minute book and corporate seal? • Are copies of all corporate documents, resolutions, and stock certificates in the minute book? • Will the law firm or the corporation hold the minute book? Apply for an Employer Identification Number • Has the client applied for an Employer Identification Number (EIN) for the corporation or will it request counsel to do so? Other Considerations • Are any state filings required in the state of incorporation? • Are any state or county business licenses required in connection with corporation’s business? For example, if the corporation will operate a restaurant it may need several licenses. • If the corporation will conduct business in other states, have all of the necessary foreign qualification forms been filed? • Does the client need or want a stockholders’ agreement? • If two or more parties are forming the corporation, have they been advised of their rights to seek separate counsel in relation to their individual interests? © 2019 Thomson Reuters. No claim to original U.S. Government Works. 4 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... Forming and Organizing a Corporation (CA) by Practical Law Corporate & Securities Maintained • California This Practice Note explains the process, steps, and documents required to form a for-profit corporation in California. It discusses initial considerations, pre-incorporation logistics, drafting and filing formation documents, post-incorporation logistics, and other important considerations. Contents Pre-Incorporation Planning: Initial Considerations State of Incorporation Special Types of California Business Corporations Statutory Close Corporation Professional Corporation Social Purpose Corporation Benefit Corporation C- or S-Corporation Name of Corporation Requirements and Restrictions Name Availability Name Reservation Fictitious Business Names © 2019 Thomson Reuters. No claim to original U.S. Government Works. 1 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... Pre-Incorporation Logistics Ordering a Minute Book Determining Whether to Use a Service Company to File the Articles of Incorporation Determining Whether the Filing Needs to be Precleared or Expedited Choosing the Initial Agent for Service of Process Choosing the Incorporators Choosing the Initial Directors Choosing the Initial Officers Confirming the Availability of Signatories Draft Formation and Organizational Documents Articles of Incorporation Required Provisions Optional Provisions Filing the Articles of Incorporation Statement of Information Bylaws Organizational Action Issuance of Shares Shareholder Agreements Close Corporations Obtaining Signatures and Delivering Documents Post-Incorporation Logistics Tax Credits and Incentives Further Assistance Pre-Incorporation Planning: Initial Considerations When forming a business in California, the first step is deciding what type of entity is best (for example, a corporation, partnership, or limited liability company). The best entity form depends on structure, liability, tax, and management © 2019 Thomson Reuters. No claim to original U.S. Government Works. 2 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... considerations (see Choosing an Entity Comparison Chart (CA), and Practice Note, Choice of Entity: Tax Issues). Corporations are a common form for entities that: • Have a formal management structure. • Are currently or may become a public company. • Have owners (shareholders) or management (directors and officers) that desire: • predictable and recognized legal structure; • limited liability; and • relative flexibility in transferring ownership interests; and • perpetual existence. When deciding to incorporate, there are several threshold issues to consider. The following is a list of key questions to answer and decisions to make before forming a California corporation. State of Incorporation Before forming a corporation, it is necessary to determine the preferred state of incorporation. Corporations are generally governed by the laws of the state of incorporation. The California Corporations Code (Code) (Cal. Corp. Code §§ 1 et seq.) governs the organization of, and procedural rules for transactions involving, a California corporation and includes provisions concerning: • Filing requirements. • The f of the corporation’s directors and officers. • The corporation’s shares and shareholder rights. • Mergers, conversions, reorganizations, and asset sales. Many corporations based in California chose California as the state of incorporation. Delaware is also a common state for incorporation for corporations based in California for a variety of reasons: • Low franchise taxes. • Ease of filing and online services. • Well-developed body of corporate law. • Respected judicial bench in corporate law. • Business-friendly statutes and decisions. A corporation based in California but formed in another state (such as Delaware) must pay additional fees to register as a foreign entity if it is doing business in California. For more information on qualifying a foreign entity to do business in California, see Qualifying a Foreign Entity to do Business in California Checklist. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 3 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... The shareholders should consider where the corporation will primarily transact its business and if there are any business, tax, social, or policy reasons for choosing a particular state. If the corporation is going to conduct a regulated business in a state other than California, it may be easier to obtain the necessary state licenses if it is a domestic corporation within the state. For example, if someone living in California was considering forming a corporation that would primarily do business across the border in Nevada, then Nevada law may be more appropriate. For more information about choosing California or Delaware as a jurisdiction of incorporation, see Choosing a Jurisdiction Comparison Chart: C-Corporations (DE and CA) and Choosing a Jurisdiction Comparison Chart: S-Corporations (DE and CA). Special Types of California Business Corporations A California corporation may choose to be classified as one or more of the special types of corporation listed below (for example, a close corporation may also be a social purpose corporation) provided its articles of incorporation satisfy the statutory requirements for that classification: • Statutory close corporation. • Professional corporation. • Social purpose corporation. • Benefit corporation. Statutory Close Corporation A close corporation is a corporation that conforms to certain statutory requirements (including a required statement in the articles of incorporation) and does not have: • More than 35 shareholders of record. • Publicly traded shares. (Cal. Corp. Code §§ 158(a), 418(c), and 421.) A close corporation can be a practical alternative to a partnership by allowing a limited number of individuals that actively participate in the corporation’s operations to take advantage of the corporate form, which includes the limitation of personal liability for the acts of the corporation. For further discussion of the potential advantages and disadvantages of close corporations, see Cal. Prac. Guide Corps. Ch. 3-D §§ 3:245 et seq. and Cal. Prac. Guide Corps. Ch. 3-D §§ 3:269 et seq. Professional Corporation The Moscone-Knox Professional Corporation Act (Cal. Corp. Code §§ 13400 et seq.) allows the formation of a corporation to render certain licensed professional services, but only through licensed individuals (Cal. Corp. Code § 13405(a)). In addition to being subject to general corporation law, a professional corporation must also comply with the regulations of the state agency that licenses the professional activity (Cal. Corp. Code §13410(a) and Cal. Prac. Guide Corps. Ch. 2-E § 2:245). A professional corporation can provide an advantage over other entity forms, such as a partnership, for individuals engaged in licensed activities subject to malpractice claims. While an individual cannot be absolved of personal liability for their own malpractice, the professional corporation does limit that individual’s vicarious liability for the malpractice of other practicing professionals in the corporation (T & R Foods, Inc. v. Rose (1996) 47 Cal. App.4th Supp. 1, 8-10). For further discussion of considerations unique to professional corporations, see Cal. Prac. Guide Corps. Ch. 2-E § 2:272. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 4 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... Social Purpose Corporation A social purpose corporation (SPC) is a for-profit corporation that, under the Social Purpose Corporations Act (Cal. Corp. Code §§ 2500 et seq.) may also pursue environmental or other public purpose objectives (Cal. Corp. Code § 2602(b)(2)). This additional purpose may be appealing to consumers or investors, depending on the corporation’s market and sources of capital. The SPC’s annual report must include a management discussion and analysis addressing the SPC’s public purpose (Cal. Corp. Code § 3500(b)). For further discussion of SPCs, see Cal. Prac. Guide Corps. Ch. 9-A §§ 9:1 et seq. Benefit Corporation A benefit corporation is a for-profit corporation that has the purpose of creating general public benefit (Cal. Corp. Code § 14610(a)). Unlike directors of other types of corporations, a benefit corporation’s directors are not required to perform their duties in the best interests of shareholders (although they must perform their duties in the best interests of the corporation, and consider the impact of any action or proposed action on shareholders) (Cal. Corp. Code § 14620(a), (b)(1)). This allows the benefit corporation to address and promote socially desirable goals while balancing the economic benefits of the shareholders. The benefit corporation’s annual report to shareholders must assess the corporation’s social and environmental performance, using a third-party standard consistently applied (Cal. Corp. Code § 14630(a)(2)). For further discussion of benefit corporations, see Cal. Prac. Guide Corps. Ch. 9(II)-A §§ 9:500 et seq. C- or S-Corporation The most common corporate form is the C-corporation. References to corporations are usually to C-corporations. C-corporation income is generally subject to two levels of US federal income tax: • At the corporate level when earned. • At the shareholder level when profits are distributed as dividends or other distributions. Corporations can avoid this double taxation by electing to be treated as an S-corporation, which is a pass-through entity for US federal income tax purposes. An S-corporation does not pay an entity level tax. Profits and losses instead pass through to its shareholders that report and are taxed on their respective share of those items on their own US federal income tax returns, whether or not distributed (see Practice Note, Choice of Entity: Tax Issues). However, this form of corporation may not always be available because there are limitations on the availability of this election, such as restrictions on the number, type, and residency of shareholders. While California recognizes, for state purposes, the S-corporation election for federal purposes, it still imposes a 1.5% franchise tax on the corporation’s net income (Cal. Rev. & Tax. Code § 23802(b)(1) and Cal. Prac. Guide Corps. Ch. 2-C § 2:120). For more information on S-corporation US federal taxation matters, see Practice Note, Taxation of S-Corporations. Basic California state tax information is available on the California Franchise Tax Board’s website (see California Franchise Tax Board). Parties should consult with a tax attorney or certified public accountant familiar with both state and federal taxation issues before forming an entity. Name of Corporation Before drafting formation documents or making any filings, determine the name of the corporation. Requirements and Restrictions The name of a California corporation must not: © 2019 Thomson Reuters. No claim to original U.S. Government Works. 5 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • Contain the words “bank”, “trust”, “trustee”, or related words unless approved by the Commissioner of Business Oversight. • Be likely to mislead the public, as determined by the California Secretary of State (SOS). • Be the same or deceptively resemble a corporate name already on record, unless the holder of the original name consents to its use and the SOS finds that the public is not likely to be misled. (Cal. Corp. Code §§ 201(a), (b).) For a discussion of name restrictions and guidelines generally, including name restrictions of other forms of corporations, such as close corporations and social purpose corporations, see Cal. Prac. Guide Corps. Ch. 3-H §§ 3:402 et seq. Name Availability To avoid possible delays in filing the articles of organization, parties can informally check the availability of a business name by performing a search on the SOS website (see Secretary of State: Business Search). Parties can formally check the availability of a business name by: • Mailing a Secretary of State: Name Availability Inquiry Letter to the SOS. • For parties that regularly check name availability, setting up a prepay account with the SOS for Priority Telephone Service, by email to Secretary of State: Email Prepaid Accounts or telephone at (916) 653–1233. Parties should have backup name choices in case a name is already taken or rejected. If an attorney is handling the name availability search or a name reservation filing, the attorney should have the alternate names to save time and avoid having to contact the client each time a name is rejected. Checking the name does not reserve or confer any rights to the name. The fact that a name is available does not mean that it satisfies the statutory requirements set out in the Code or that the SOS will approve it. Parties should not take any action in reliance on the availability of a name. If the corporation intends to use its name as a trademark, service mark, domain name, or trade name, consider running a trademark and copyright search to see if another business has registered the name. These searches can be conducted for free online at the United States Patent and Trademark Office. Name Reservation Parties can reserve a business name in advance for a period of up to 60 days (Cal. Corp. Code § 201(d) and see Secretary of State: Name Reservation Request). The Code does not permit the same or a deceptively similar name to be reserved for the same party for consecutive 60 day periods (Cal. Corp. Code § 201(d)). To renew a previously reserved name, a party must wait at least one business day before submitting a new name reservation request (if the name has not been reserved by another party in the interval). For more information on filing a name reservation request, including filing and payment methods, filing and additional fees, expedited filing, and required supporting documents, see Practice Note, Filing Documents with the Secretary of State (CA). The SOS reviews names for compliance when the articles of incorporation are filed. Parties should not rely on a reserved business name, as reserving the name does not guarantee the SOS will approve it. Fictitious Business Names © 2019 Thomson Reuters. No claim to original U.S. Government Works. 6 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... A corporation doing business in California under a name other than its legal name must file a fictitious business name (FBN) statement with the office of the county clerk (and not the SOS) of either: • The county where the corporation’s principal place of business in California is located. • Sacramento County, if the corporation does not have a place of business in California. (Cal. Bus. & Prof. Code § 17915.) Parties should confirm the procedures and fees for filing and registering the corporation’s FBN statement with each county in which the corporation must file the statement. After filing the FBN statement, the corporation must: • Within 30 days of filing, publish the FBN statement in a newspaper of general circulation in: • the county where the FBN statement was filed; • an adjoining county (if the county of filing has no newspaper of general circulation); or • Sacramento County, if the LLC has no place of business in California. • Within 30 days after completion of publication, file an affidavit of publication with the office of the county clerk in the county where the statement was filed. (Cal. Bus. & Prof. Code § 17917(a), (d).) An LLC may file an FBN statement in other counties (Cal. Bus & Prof Code § 17915). For more information on FBNs, see Fictitious Business Names in California Checklist. Pre-Incorporation Logistics After determining the state of incorporation, the type of corporation, whether the corporation will be a C- or S-corporation, and the name of the corporation, the next steps to take include: Ordering a Minute Book A minute book (sometimes referred to as a corporation kit) is a loose ring binder that acts as a place to store minutes of the board of directors and shareholder meetings, the articles of incorporation, bylaws, share register, and share certificates. The minute book usually comes with a form of articles of incorporation, bylaws, corporate seal, specimen share certificate, and share register. The corporation can replace any of the included forms with its own, however counsel should confirm that any self-drafted forms (as well as any included forms the corporation doesn’t replace) conform to current law. A corporation must keep the following records: • Bylaws and any amendments. • Accounting and tax books and records. • Minutes of all proceedings of shareholders, board of directors, and any board committees. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 7 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • A record of shareholders, including each shareholder’s name, address, and number and class of shares held. (Cal. Corp. Code §§ 213 and 1500 and see Cal. Prac. Guide Corps. Ch. 6-F §§ 6:495 et seq.) The corporation can maintain its records in electronic or other form if they can be converted into clearly legible tangible form (Cal. Corp. Code § 1500). As an alternative to or in conjunction with storing paper versions in an official minute book, the corporation should consider scanning or creating electronic copies of its records and maintaining them in a secure, searchable database. Determining Whether to Use a Service Company to File the Articles of Incorporation For a fee, a service company can help file any document with the SOS on behalf of the corporation. Using a service company can provide quicker turn-around times, advancing of filing fees, experience with filing requirements and procedures, and convenience. While it is not a requirement, many firms and corporations use service companies. These corporations and law firms typically have a relationship or account with a particular service company. If using a service company, call the service company’s representative before filing to determine their fees for handling the filing. Determining Whether the Filing Needs to be Precleared or Expedited The SOS offers preclearance and expedited filing services for a fee (see Practice Note, Filing Documents with the Secretary of State (CA) and Secretary of State: Preclearance and Expedited Filing Services). For information on current processing times, go to Secretary of State: Current Processing Times. Confirm that the client has authorized any preclearance or expedite charges before ordering. Although there is an extra charge, preclearance and expedited processing may be necessary if the corporation is being formed in connection with a time-sensitive transaction. Choosing the Initial Agent for Service of Process A California corporation must designate and maintain an agent for service of process in California, which may be either: • A natural person who resides in California. • A domestic or foreign corporation that has filed the required certificate with the SOS and otherwise complied with Section 1505 of the California Corporations Code, including being authorized to do business and being in good standing in California (Cal. Corp Code § 1505). (Cal. Corp Code § 1502(b).) Choosing the Incorporators If the articles of incorporation do not name the initial directors, the articles of incorporation must be signed by one or more incorporators. An incorporator may be a natural person, partnership, association, or corporation. (Cal. Corp. Code § 200(a), (b).) An attorney often acts as the incorporator, but this is not required, and may not be advisable in some instances, since the incorporator has responsibility for the corporation until the board of directors has been elected. For further discussion of the role of incorporators, see Standard Document, Organizational Action by Sole Incorporator of a Corporation (CA) and Cal. Prac. Guide Corps. Ch. 3-H §§ 3:418 et seq. Choosing the Initial Directors © 2019 Thomson Reuters. No claim to original U.S. Government Works. 8 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... If the articles of incorporation do not name the initial directors, the incorporators have the initial authority to complete the corporation’s organization, including adopting bylaws and electing directors and officers (Cal. Corp. Code §210). There may be advantages in naming the directors in the articles of incorporation, including avoiding potential delays in the corporation’s business activities or deficiencies in the organizational process. If the directors are not named in the articles of incorporation, the incorporators must elect them before the organizational meeting (see Cal. Prac. Guide Corps. Ch. 4-E § 4:399). For more information on directors, see Standard Document, Bylaws (CA): Drafting Note: Powers; Qualifications. Choosing the Initial Officers A corporation must have: • A chairperson of the board or a president or both. • A secretary. • A chief financial officer. (Cal. Corp. Code § 312(a)). A corporation may have other officers as set out in the bylaws or determined by the board of directors. The same person may hold two or more offices unless otherwise provided by the articles of incorporation or bylaws. (Cal. Corp. Code § 312(a).) For example, a corporation may have a treasurer and one or more vice-presidents (see Cal. Prac. Guide Corps. Ch. 4-F §§ 4:429 and 4:430). The directors typically elect officers as one of their first organizational actions at their initial meeting (or written action in lieu of a formal meeting). If the articles of incorporation do not name the initial directors, the incorporators have the authority to elect officers (Cal. Corp. Code § 210). Confirming the Availability of Signatories Parties should confirm the availability of signatories before appointing them, especially if the corporation is being formed for a specific and imminent purpose. For example, if a corporation is formed to make an acquisition: • The directors must be available to sign resolutions authorizing the acquisition documents. • At least one of the officers must be available to sign the acquisition agreement. Draft Formation and Organizational Documents In addition to the articles of incorporation, which is the only document that must be filed with the SOS, several other documents are needed to properly form and organize a California corporation. Before drafting these documents, obtain the necessary information, such as the identity of the directors and the agent for service of process in California. Articles of Incorporation In California, a corporation may file articles of incorporation by using one of the following: • Form ARTS-GS, Articles of Incorporation of a General Stock Corporation, a fillable form for the formation of a general stock corporation provided by the SOS. • Form ARTS-CL, Articles of Incorporation of a Close Corporation, a fillable form for the formation of a close corporation provided by the SOS. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 9 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • Form ARTS-PC, Articles of Incorporation of a Professional Corporation, a fillable form for the formation of a professional corporation provided by the SOS. • A self-drafted form of any of the above that conforms to the Code’s requirements (Cal. Corp. Code § 202). For self-drafted forms of articles of incorporation, including discussion of drafting considerations, specific requirements (based on the type of corporation) and filing advice, see Standard Documents: • Articles of Incorporation: General Stock Corporations (CA). • Articles of Incorporation: Close Corporations (CA). • Articles of Incorporation: Professional Corporations (CA). • Articles of Incorporation: Benefit Corporations (CA). • Articles of Incorporation: Social Purpose Corporations (CA). The Code specifies both required and optional provisions for the corporation’s articles of incorporation (Cal. Corp. Code §§ 202 and 204). For more information on preparing California articles of incorporation generally, see Cal. Prac. Guide Corps. Ch. 4-A. Required Provisions The articles of incorporation must include all of the following: • The name of the corporation (see Name of Corporation). • The purpose of the corporation, set forth in specific statutory language. • The name and street address of the corporation’s initial agent for service of process. • The corporation’s street address and mailing address (if different from the street address). • The authorized share structure of the corporation (see Cal. Prac. Guide Corps. Ch. 4-A §§ 4:35 et seq.). (Cal. Corp. Code § 202.) Optional Provisions The articles of incorporation may contain other provisions not inconsistent with law relating to the management of the business and the conduct of the affairs of the corporation (Cal. Corp. Code § 204(d)). Parties should be cautious on how and to what extent additional terms are included in the articles because they are publicly filed. For a private corporation, the articles typically contain only the required and other basic information while all other provisions are included in the bylaws (see Bylaws). Certain optional provisions, however, are effective only if included in the articles of incorporation. When drafting articles, parties may want to consider adding one or more of these provisions to modify the Code’s statutory defaults: • The right to levy assessments on the shares or any class of shares. • Preemptive rights granted to shareholders to subscribe to any or all issues of shares or securities. • Special qualifications of prospective shareholders. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 10 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • Limiting the corporation’s duration to a specified date. • Requiring a supermajority vote or quorum for any or all corporate actions (supermajority requirements may be imposed by statute for certain actions even if not included in the articles of incorporation). • Limiting or restricting the corporation’s powers or business. • Granting voting rights to holders of any evidences of indebtedness, issued or to be issued by the corporation. • Shareholders’ right to determine the consideration for issued shares. • Requiring shareholder approval or the approval of outstanding shares for any corporate action, when this approval is not otherwise required by the Code. • Eliminating or limiting director liability for breach of fiduciary duty within certain limits. • Indemnifying the corporation’s agents (for example, a director). (Cal. Corp. Code § 204(a).) For a discussion on including optional provisions in the articles of incorporation, see Cal. Prac. Guide Corps. Ch. 4-A §§ 4:50 et seq. Filing the Articles of Incorporation After the articles of incorporation have been prepared, executed, and acknowledged (acknowledgment is needed for each signature of a director only if directors are named), the original articles of incorporation must be filed with the SOS, accompanied by payment of the applicable fees (Cal. Corp. Code § 200(a)). If a name has been reserved (see Name Reservation), a copy of the name reservation certificate should be included to avoid rejection for an unavailable name. The fee to file the articles of incorporation by mail is $100 (Cal. Gov’t Code § 12186(c)). If filing in person, an additional $15 non-refundable special handling fee is required which must be paid by separate check. Checks or money orders must be made payable to “Secretary of State”. If submitting articles in person in the Sacramento office, fees may also be paid by credit card (Visa or MasterCard). Confirm current fees on the SOS website (see Secretary of State: Business Entities Fee Schedule). For more information on filing the articles of incorporation, including filing and payment methods, filing and additional fees, expedited filing, and required supporting documents, see Practice Note, Filing Documents with the Secretary of State (CA) and Secretary of State: Corporate Filing Tips. Statement of Information A new corporation must file a Form SI-550 Statement of Information with the SOS within 90 days after filing its original articles of incorporation and annually thereafter (Cal. Corp. Code §§ 1502(a), (b) and see Secretary of State: Form SI-550). If there has been no change in any of the information contained in the previous complete statement of information, a corporation may instead file a Form SI-550 NC Statement of No Change (Cal. Corp. Code § 1502(c) and see Secretary of State: Form SI-550 NC). The fee to file the initial or an annual statement of information or an annual statement of no change by mail is $25 (which includes a $5 disclosure fee). There is no fee to file (by mail) a statement of information submitted between filing periods to report a change of information. (Cal. Corp. Code § 1502(d) and Cal. Gov’t Code §§ 12186(g), (i) and see Secretary of State: Form SI-550.) If filing in person, an additional $15 non-refundable special handling fee is required which must be paid by separate check. Confirm current fees on the SOS website (see Secretary of State: Business Entities Fee Schedule). Bylaws Bylaws are the internal governance rules of a corporation. The bylaws may contain any provision, consistent with law and the © 2019 Thomson Reuters. No claim to original U.S. Government Works. 11 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... articles of incorporation, for the management of the business and the conduct of the affairs of the corporation (Cal. Corp. Code § 212(b)). Although the Code does not explicitly require a corporation to adopt bylaws, nearly all corporations do, and a corporation must keep an original or copy of its bylaws at its principal executive office or principal business office in California (Cal. Corp. Code § 213). A corporation must adopt bylaws if its articles of incorporation do not state the number (or maximum and minimum number) of directors. In this case, the incorporators must adopt bylaws specifying the number (or maximum and minimum number) of directors before the first board meeting. (Cal. Corp. Code § 212(a) and see Cal. Prac. Guide Corps. Ch. 4-D § 4:172.) Bylaws function as regulations among the shareholders, directors, and officers of the corporation. Typical areas covered in the bylaws include: • Procedures for meetings of shareholders and directors (including record date, notice, and voting). • Procedures for the election, removal, and compensation of directors and officers. • Issuance and transfer of shares of the corporation. • Granting officers authority to execute agreements on behalf of the corporation. • Defining the scope of indemnification of directors, officers, employees, and agents (Cal. Corp. Code § 317). Bylaws may be adopted, amended, or repealed by either: • The incorporators prior to the election of directors. • The outstanding shares of the corporation (Cal. Corp. Code § 152). • The directors, unless restricted by the bylaws or articles and subject to certain statutory exceptions. (Cal. Corp. Code §§ 210 and 211.) For more information on drafting the bylaws, see Standard Documents, Bylaws (CA) and Cal. Prac. Guide Corps. Ch. 4-D. Organizational Action If the articles of incorporation do not name the initial directors, the incorporators may, until the directors are elected, take any action necessary and proper to complete the organization of the corporation, including: • Adopting bylaws. • Electing directors and officers. (Cal. Corp. Code § 210.) The incorporators typically only elect the initial directors and, if necessary, a bylaw establishing the number or minimum and maximum number of authorized directors (if not set forth in the articles). The directors then complete the organization of the corporation. Actions typically taken by the directors as part of the organizational action include, but are not limited to: © 2019 Thomson Reuters. No claim to original U.S. Government Works. 12 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • Adopting bylaws. • Electing officers. • Approving the form of certificate for the corporation’s shares (unless uncertificated). • Accepting subscriptions for, and issuing shares to, the shareholders. • Determining the corporation’s fiscal year. • Authorizing the opening of bank accounts. • Establishing borrowing authority. • Establishing officers’ salaries if the directors have elected officers. • Approving contracts. • Ratifying an S-corporation election for tax purposes, if applicable (see C- or S-Corporation). For further discussion of organizational action by directors, see Cal. Prac. Guide Corps. Ch. 4-F. For examples of organizational action taken by written consent, see Standard Documents, Unanimous Written Consent of the Board in Lieu of Organization Meeting (CA) and Organizational Action by Sole Incorporator of a Corporation (CA). Issuance of Shares A corporation raises capital by selling and issuing shares. The articles of incorporation set the number, classes, and series of shares and their rights, preferences, privileges, and restrictions or, in certain circumstances, such as the determination of the rights, preferences, privileges, and restrictions of an unissued class of shares, may authorize the board of directors to make the determination (Cal. Corp. Code §§ 202(f), (g)). Consideration for shares can include: • Money paid. • Labor performed. • Property (tangible or intangible) actually received. • Services actually rendered (but not future services) to or for the benefit of the corporation or in its formation. • Cancellation of debt or securities. (Cal. Corp. Code § 409(a)(1).) Each shareholder is entitled to a physical share certificate unless the corporation has adopted an electronic system permissible under the Code (along with the required notice). Each physical share certificate must certify the number of shares and the class or series of shares owned by each shareholder and be signed by both: • The chairperson or vice-chairperson of the board, the president, or a vice-president. • The chief financial officer, an assistant treasurer, the secretary, or an assistant secretary. (Cal. Corp. Code § 416.) For a discussion on the contents of certificates, see Cal. Prac. Guide Corps. Ch. 5-D §§ 5:447 et seq. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 13 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... As an alternative to share certificates, a corporation may adopt a system of share issuance, registration and transfer by electronic or other means not involving the physical issuance of share certificates (Cal. Corp. Code § 416(b)). The system must be approved by the Securities and Exchange Commission (SEC) or otherwise be authorized by any statute or in accordance with Division 8 of the California Commercial Code (Cal. Com. Code §§ 8101 et seq.). The system must also comply with any rules adopted by the Corporations Commissioner (Cal. Corp. Code § 416(b)). The corporation must keep a record of shareholders’ names, addresses, and number and class of shares held (Cal. Corp. Code § 1600(a) and see Ordering a Minute Book). Counsel should consider whether there are any registration or notification requirements under applicable federal and state securities laws (for example, the Securities Act of 1933, as amended (15 U.S.C. §§ 77a et seq.) and the California Corporate Securities Law of 1968 (Cal. Corp. Code §§ 25100 et seq.)). Unless there is preemption by federal law, a person generally cannot legally offer or sell any security in California unless the transaction is qualified or exempt (Cal. Corp. Code §§ 25102 and 25110). For a discussion of California securities laws requirements generally, see Cal. Prac. Guide Corps. Ch. 5-C. Counsel should also review the securities statutes and regulations in any state besides California where the shares will be offered or sold and comply with all applicable requirements. Before authorizing another class of shares beyond common shares, the parties should confirm that the corporation will be classified as a C-corporation for federal tax purposes. To qualify for S-corporation status, a corporation may not have more than one class of shares except for classes distinguishable only by voting rights and not by rights to distributions or allocations of profit and loss (IRC §§ 1361(b)(1)(D), (c)(4) and see C- or S-Corporation). Shareholder Agreements Although not required, shareholders sometimes enter into agreements with each other at the time of formation to anticipate and provide for the resolution of matters that may be of later concern or disruption, including: • Control and management of the corporation. • Initial and future capital contributions. • Ownership and voting rights or obligations. • Supermajority voting requirements for specified corporate actions. • Restrictions on the transfer of shares, such as pre-emptive rights or rights of first refusal. • Resolution of disputes and deadlock. • Preventing a shareholder from competing with the corporation, soliciting customers, or revealing trade secrets if the shareholder sells its interest. Two or more shareholders may effectively pool their votes by entering into a written agreement providing that their shares will be voted on certain matters as provided in the agreement, as agreed by the parties, or as determined by an agreed-upon procedure. The agreement may be enforced by specific performance. (Cal. Corp. Code § 706(a) and see Cal. Prac. Guide Corps. Ch. 3-B § 3:159.3.) For resources to assist in preparing and evaluating agreements among shareholders, see Stockholders (Shareholders) Agreements Toolkit. For an example of a shareholder agreement in a closely held corporation that restricts the transfer of shares to third parties, see Standard Document, Buy-Sell Agreement (General Form): Corporations. Close Corporations Shareholders in a statutory close corporation may enter into a shareholders’ agreement that sets out the matters on which the © 2019 Thomson Reuters. No claim to original U.S. Government Works. 14 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... shareholders (and not the board of directors) will exercise management control (Cal. Corp. Code § 300(b) and see Cal. Prac. Guide Corps. Ch. 3-D §§ 3:243 and 3:248 et seq.). Subject to certain statutory exceptions, a shareholders’ agreement may govern any of a statutory close corporation’s affairs. Shareholders exercising management control under a shareholders’ agreement are subject to the liability that would otherwise be imposed on directors for performing (or failing to perform) managerial acts. (Cal. Corp. Code § 300(b) to (d).) Shareholders in a statutory close corporation sometimes enter into buy-sell or buy-out agreements, intended to preserve ownership continuity, provide for orderly succession of ownership, and avoid disputes. These agreements may: • Restrict a transfer of shares to unrelated third parties or establish procedures for a transfer (for example, giving other shareholders the opportunity to buy the shares). • Provide a manner for resolving major events, such as a shareholder’s death or divorce. For a discussion of buy-out agreements generally, see Cal. Prac. Guide Corps. Ch. 3-C. For an example of an agreement that restricts the transfer of shares to third parties, see Standard Document, Buy-Sell Agreement: Corporations (CA). Obtaining Signatures and Delivering Documents It is crucial to obtain all necessary signatures and date the documents so that they are legally binding. Copies of all documents should be filed in the minute book of the corporation so that the corporation can prove that it observed all necessary formalities (see Ordering a Minute Book). After the articles of incorporation are filed, counsel must: • Verify that the organizational actions of the corporation have been taken by either the incorporators or the board of directors by a unanimous written consent or at a formal meeting. Once these documents are complete, file them in the corporation’s minute book. • Arrange for the full execution of any subscription agreements and share certificates. Once these documents are complete, deliver the originals to the shareholders and file a copy of each in the corporation’s minute book. All share issuances should be recorded in the share ledger. • Arrange for the full execution of any shareholder agreements. Once these documents are complete, deliver the originals to the shareholders and file a copy of each in the corporation’s minute book. Post-Incorporation Logistics Once the corporation is formed and the directors and officers are elected and appointed, there are additional steps to complete before the corporation can begin doing business: • File for any necessary foreign qualifications. If the corporation will conduct business in other states, it must be properly qualified. While specific requirements of each state vary, qualification typically involves: • checking the name availability of the corporation in that state; • preparing and filing any necessary document (often called a certificate of authority), which often contains similar information to the articles of incorporation and includes a submission to service of process in that state; and • paying fees. • Apply for an Employer Identification Number (EIN) with the Internal Revenue Service (IRS). An EIN is necessary for tax filing and reporting purposes and to identify the corporation. It is often required before a corporation can transact any © 2019 Thomson Reuters. No claim to original U.S. Government Works. 15 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... business or even open a bank account. A corporation can apply for an EIN on the Internal Revenue Service’s website (see IRS: Apply for an Employer Identification Number (EIN) Online). There is no application fee. • File for any necessary intellectual property protection, including: • a state trademark with the SOS (see Secretary of State: Trademarks and Service Marks); • a federal patent or trademark with the US Patent and Trademark Office (see United States Patent and Trademark Office); and • a federal copyright with the US Copyright Office (see United States Copyright Office). • Apply for any required licenses, permits, or certifications, including: • federal or state business or occupational licenses and permits necessary for the operation of the business; and • local permits needed for the operation of the business, such as building, health, food and beverage, and zoning. For an overview of employment laws and human resources issues that may apply to new and expanding California companies, see Practice Note, California Employment Law Issues for Startups, Entrepreneurs, and Growing Businesses: Overview. For an overview of the types of equity compensation commonly used by new companies for employees, see Practice Note, Choosing the Right Type of Equity Compensation for Startup Company Employees. Tax Credits and Incentives Determine if the corporation is eligible for any beneficial tax credits or incentives, such as: • California Competes Tax Credit. • California Motion Picture and Television Production Credit. • California Research Credit. • Economic Development Area Credits. • New Employment Credit. Further Assistance A corporation can seek advice or assistance from various local, state, or federal programs to help the corporation’s business, including: • US Small Business Administration (SBA). Programs and information that the SBA offers include the following: • 8(a) Business Development Program, an SBA program designed to help small, disadvantaged businesses; • Historically Underutilized Business Zone (HUBZone) Program, a program designed to help small businesses in urban and rural communities gain access to federal procurement opportunities; © 2019 Thomson Reuters. No claim to original U.S. Government Works. 16 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing a Corporation (CA), Practical Law Practice Note w-000-3594... • Women-Owned Small Businesses (WOSB) Federal Contract Program, a program designed to provide greater access to federal contracting opportunities for WOSBs and economically-disadvantaged women-owned small businesses; • Service-Disabled Veteran-Owned Small Business Concern (SDVOSBC) Procurement Program, a program designed to provide SDVOSBCs with exclusive competition to federal procurement opportunities; and • SBA California State Local Assistance Resources. • SCORE, a non-profit association for the benefit of entrepreneurs and small businesses (SCORE). • Minority Business Development Agency (MBDA). (MBDA is a part of the US Department of Commerce). • California Governor’s Office of Business and Economic Development (GO-Biz). (Go-Biz is a point of contact for economic development and job creation efforts offering a range of services to business owners). • State of California Employment Development Department (EDD). (EDD provides employer assistance for workforce recruitment and training.) • Governor’s Office of Business and Economic Development provides information relating to California permits. • California Division of Workers’ Compensation and the California Employment Development Department contain information relating to being an employer in California. • Employment Training Panel (ETP). (ETP funds the cost of vocational training.) • Chambers of Commerce: • national: US Chamber of Commerce; • state: California Chamber of Commerce; and • local. © 2019 Thomson Reuters. No claim to original U.S. Government Works. 17 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Forming and Organizing an LLC (FL) by Practical Law Corporate & Securities Law stated as of 04 Oct 2018 • Florida This Practice Note is a guide to the procedural steps, documents, and considerations necessary to form a limited liability company (LLC) in Florida, including a professional limited liability company. This Note discusses initial considerations, organizational documents, pre- and post-formation matters, and other important issues. Contents Initial Considerations State of Formation Name of the LLC Pre-Formation Logistics Articles of Organization Filing the Articles of Organization Professional Limited Liability Company Operating Agreement Considerations Regarding Ownership Interests Initial Acts of the Members or Managers Post-Formation Matters Preparing the Minute Book and Ledger Apply for a Taxpayer Identification Number Obtain Licenses and Permits © 2019 Thomson Reuters. No claim to original U.S. Government Works. 1 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Tax Considerations Employee Incentive Considerations Capital Raising Considerations Further Assistance Initial Considerations When forming a business in Florida, the first step is deciding what type of entity is best (for example, a corporation, partnership, or limited liability company (LLC)). The best entity form depends on structure, liability, tax, and management considerations (see Choosing an Entity Comparison Chart (FL)). LLCs offer substantial flexibility and combine the liability protection of a corporation with the tax treatment of a partnership. For these reasons, LLCs are increasingly popular business entities. Advantages of an LLC include: • Limited liability of the members for the LLC’s debts. A member is an individual or entity who is an undissociated member of the LLC (§§ 605.0102(40), (48), 605.0401, and 605.0602, Fla. Stat.). • Greater flexibility in allocating profits among members. • Freedom to contract for the management of the LLC’s business, often superseding default statutory requirements. • Fewer formalities than with a corporation (for example, an LLC is not required to have annual meetings or keep written minutes of its proceedings). • Pass-through taxation to avoid double taxation, unless the members choose an alternative tax classification (see Practice Note, Choice of Entity: Tax Issues). • Fewer restrictions on ownership. Disadvantages of an LLC include: • Additional hurdles if the LLC plans to eventually become a public company. • Generally more complex than a partnership. • The income of certain members may be subject to self-employment tax (see Practice Note, Dual Status: Treating Partners as Employees: Wage Withholding and Payroll Taxes – Partners). When deciding to form an LLC, there are also several threshold issues to consider. For information on certain principal issues involved with forming an LLC, see Forming an LLC Checklist. For additional state-specific issues to consider before preparing a comprehensive operating agreement, see Operating Agreement Checklist (FL). State of Formation Before forming an LLC, organizers must determine the preferred state of formation. LLCs are governed by the laws of the state of formation. In Florida, the Florida Revised Limited Liability Company Act (RLLCA) (§§ 605.0101 et seq., Fla. Stat.) governs the management and operation of an LLC and includes provisions concerning: © 2019 Thomson Reuters. No claim to original U.S. Government Works. 2 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) • Formation. • Management by members or managers. A manager is a person or entity that is responsible under an operating agreement (alone or with others) to perform the management functions set out in the RLLCA (§§ 605.0102(38), (48), 605.0407(3), and 605.04073(2), Fla. Stat.). • Contributions and distributions. • Membership, assignment of membership interests, and dissociation. • Mergers and conversions. • Dissolution. Organizers should also consider where the LLC will primarily transact its business and if there are any business, tax, social, or policy reasons for choosing a particular state. Forming an LLC in the state where it will primarily conduct business is typically the easiest and most cost effective. However, there may be business advantages, tax or otherwise, to forming an LLC in other states, such as Delaware or Nevada. If the LLC is going to conduct a regulated business in a state other than Florida, it may be easier to obtain the necessary s tate licenses if it is a domestic LLC within that state. For more information on qualifying a foreign entity to do business in Florida, see Qualifying a Foreign Entity to do Business in Florida Checklist. Name of the LLC Before drafting or filing any formation documents, determine the name of the LLC. The name of a Florida LLC must: • Contain the words “limited liability company” or the abbreviation “LLC” or “L.L.C.”. • For professional LLCs formed on or after January 1, 2014, contain the words “professional limited liability company” or the abbreviation “PLLC” or “P.L.L.C.” in lieu of the words or abbreviations used for a general LLC (§ 621.12(2)(b)(3), Fla. Stat.). • Be distinguishable from all other entities or filings in the records of the Florida Department of State, Division of Corporations (DOC), except for: • fictitious name registrations (§ 865.09, Fla. Stat.); • general partnership registrations (§ 620.8105, Fla. Stat.); and • limited liability partnership statements (§ 620.9001, Fla. Stat.). • However, an LLC may register under a name that is not otherwise distinguishable with the written consent of the owner of the similarly named entity if the consent is filed with the DOC when the indistinguishable name is registered. • Not contain language implying a purpose other than one authorized by the RLLCA and as stated in the articles of organization. • Not contain language stating or implying association with a state or federal governmental agency or corporation chartered under US laws. (§ 605.0112(1), Fla. Stat.) © 2019 Thomson Reuters. No claim to original U.S. Government Works. 3 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) A name is not distinguishable when the difference is due to: • A suffix. • A definite or indefinite article. • The word “and” and the symbol “&.” • The singular, plural, or possessive form of a word. • A recognized abbreviation of a root word. • A punctuation mark or symbol. (§ 605.0112(1)(b), Fla. Stat.) For more information on naming an LLC, see Division of Corporations: Division FAQs. To avoid possible delays in filing the articles of organization, organizers should conduct a preliminary search for name availability through the DOC’s online records (see Division of Corporations: Search for Corporations, Limited Liability Companies, Limited Partnerships, and Trademarks by Name). Names cannot be reserved in advance. Final name approval is determined by the DOC, so a name should not be used until the DOC acknowledges that the articles of organization have been accepted for filing. The DOC’s website states that the LLC is liable for any infringements resulting from the name selected (see Division of Corporations: Articles of Organization). If the LLC will transact business in Florida under any name other than its legal name, it must register that name with the DOC as required by the Florida Fictitious Name Act (§ 865.09, Fla. Stat.). For more information on using and registering a fictitious name, see Practice Note, Fictitious Names in Florida. If the LLC intends to use its name as a trademark, service mark, domain name, or trade name, organizers should run a trademark search to see if the name is currently registered by another business. These searches can be conducted for free online (see Division of Corporations: Search for Corporations, Limited Liability Companies, Limited Partnerships, and Trademarks by Name and US Patent and Trademark Office). Organizers should not take any action in reliance on the availability of a name until the DOC has filed the articles of organization. It is often a good idea, particularly if an attorney is handling the filing for a client, to have backup name choices in case a name is taken or rejected. Pre-Formation Logistics Once the state of formation and the name of the LLC have been identified, counsel should determine: • Who the organizers should be. The organizers prepare, execute, and file the articles of organization. An attorney often acts as the organizer, but the organizer does not need to be an attorney. An organizer also does not need to be a member of the LLC. (§ 605.0102(8)(a), Fla. Stat.) • Whether to use a service company to file the formation documents. Although many firms and companies have a relationship with a particular service company, using a service company is not required. If counsel does not already have a service company, check the law firm or company directory or with another member of the team for the name of the preferred service company and contact information. At law firms, paralegals often have this type of information. • The street and mailing address of the LLC’s principal office. This information must be included in the articles of organization (§ 605.0201(2)(b), Fla. Stat. and see Required Provisions). The LLC’s principal office does not have to be in Florida (§ 605.0102(54), Fla. Stat.). • The location of the LLC’s registered office. An LLC must designate and continuously maintain a registered office in © 2019 Thomson Reuters. No claim to original U.S. Government Works. 4 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Florida, which may (but need not be) the same as its place of business in the state (§ 605.0113(1)(a), Fla. Stat.). • The LLC’s registered agent. An LLC must designate and continuously maintain a registered agent whose business address is the same as the address of the LLC’s registered office and is: • an individual Florida resident; or • a foreign or domestic entity authorized to transact business in Florida. • (§ 605.0113(1)(b), Fla. Stat.) • Whether the LLC should have an indefinite duration. By default, an LLC has an indefinite duration, subject to certain dissolution events (§§ 605.0108(3) and 605.0701, Fla. Stat.). The operating agreement can vary this default rule if the LLC prefers to have a specific period of duration (§ 605.0105(2), Fla. Stat.). • Whether the LLC will render professional services. If the LLC will render professional services, such as the practice of law or medicine, there are additional statutory requirements, such as limitations on who can be a member of a professional LLC (§ 621.09(2), Fla. Stat. and see Professional Limited Liability Company). • Whether the LLC should be member-managed or manager-managed. Unless otherwise provided by the operating agreement or articles of organization, management is vested in the members (§ 605.0407(1), Fla. Stat.). • Whether the LLC should be a single-member or multi-member LLC. A Florida LLC may have one or more members (§ 605.0401, Fla. Stat.). If two or more parties are forming the LLC, they should be advised of their rights to seek separate counsel in relation to their individual interests. • The type of operating agreement. Members of an LLC may enter into one comprehensive long-form operating agreement or a series of one or more stand-alone agreements covering different matters (§ 605.0102(45), Fla. Stat.). • Whether the LLC should have majority and minority interests or be a 50/50 LLC. Majority and minority parties often have different concerns than two 50/50 members. There may be situations where an existing business wants to become an LLC. Florida law allows foreign and domestic entities that are not organized as LLCs to convert to Florida LLCs by complying with certain statutory requirements. (§§ 605.1041 et seq., Fla. Stat.) Examples of business entities that may convert to a Florida LLC include: • Corporations. • Nonprofit corporations. • Real estate investment trusts. • General partnerships. • Limited partnerships. • Limited liability partnerships. • Limited liability limited partnerships. • Any other Florida or foreign entity organized under an organic law. (§§ 605.0102(23)(a) and 605.1041(2), (3), Fla. Stat.) For more information on Florida entity conversion, see Entity Conversion and Domestication Checklist (FL). An existing business converting to a Florida LLC may have responsibilities for certain tax matters (see Department of © 2019 Thomson Reuters. No claim to original U.S. Government Works. 5 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Revenue: Considering Business Opportunities in Florida?). There may be other tax consequences associated with converting to an LLC. Therefore, the entity should seek advice from a tax professional before taking any action. Articles of Organization Under the RLLCA, a Florida LLC is formed when the articles of organization become effective and the LLC has at least one member (§ 605.0201(4), Fla. Stat.). As part of the formation process, the organizer must file the articles of organization with the DOC. Although the RLLCA only requires minimal information in the articles of organization, organizers should consider whether there are any additional provisions to include, such as a statement setting out any limitations on the authority of members or managers to bind the LLC. (§ 605.0201, Fla. Stat.) Required Provisions Under the RLLCA, the articles of organization must include: • The LLC’s name, which must comply with the RLLCA’s requirements (see Name of the LLC). • The street and mailing address of the LLC’s principal office (where the LLC’s principal executive offices are located, within or outside Florida) (§ 605.0102(54), Fla. Stat.). • The name, Florida street address, and written acceptance of the LLC’s initial registered agent. (§ 605.0201(2), Fla. Stat.) Optional Provisions Beyond these required provisions, the articles of organization can include any other provisions consistent with the law that the members want in the articles of organization for the regulation of the internal affairs of the LLC, including: • A declaration of whether the LLC is member-managed or manager-managed. • For manager-managed LLCs, the names and addresses of the managers of the LLC. • For member-managed LLCs, the names and addresses of one or more of the members of the LLC. • A description of the authority or limitation of authority of specific persons or positions in the LLC. (§ 605.0201(3), Fla. Stat.) However, an LLC should consider omitting other information not required by law from the articles of organization because: • Optional information such as details regarding membership, capital contributions, profit and loss allocations and distributions, meetings, termination provisions and other particulars of the LLC’s internal affairs and business operations, may be better left out of a public record and instead included in the LLC’s operating agreement. For more information on operating agreements, see Standard Document, Operating Agreement (Single Member) (FL). • If the information changes in the future, revising an internal governing document rather than the articles of organization offers the LLC greater flexibility and cost-savings since an amendment or restatement of the articles of organization requires an additional filing and fee (§§ 605.0202 and 605.0213(11), Fla. Stat.). Prohibited Provisions The articles of organization may not modify or otherwise alter certain matters that cannot be modified in the LLC’s operating agreement (§§ 605.0105(3) and 605.0201(3), Fla. Stat. and see Operating Agreement). © 2019 Thomson Reuters. No claim to original U.S. Government Works. 6 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Effective Date and Time If the articles of organization are silent, the default statutory effective date and time is the date and time of filing. The initial articles of organization alternatively may state a specific delayed effective date and time that is not more than 90 days after the filing date or a prior effective date not more than five business days before the filing date. If the initial articles of organization state a delayed or prior effective date without a time, the articles of organization are effective by default at 12:01 a.m. on the effective date. (§ 605.0207(3) to (4), Fla. Stat.) If the specified effective date does not meet the applicable statutory filing requirements, the effective date of the initial articles of organization is: • For a prior effective date, the later of the specified date or five business days before the filing. • For a delayed effective date, the earlier of the specified date or the 90th day after the filing. (§ 605.0207(4), (5), Fla. Stat.) The effective date of the articles of organization is typically the filing date. However, there are situations where delaying the effective date is useful. For example, the LLC may need time to prepare an operating agreement or to wait for member contributions of cash or other assets to be in place. For filings late in the year, there may also be administrative or tax advantages to delaying the effective date until the following year. For more information on creating the articles of organization, see Standard Document, Articles of Organization (FL). A sample form for the articles of organization is also available on the DOC’s website (see Division of Corporations: Articles of Organization). Filing the Articles of Organization Organizers may file the articles of organization online, by mail, by walk-in service, or by fax. For more information on filing documents with the DOC, see Practice Note, Filing Documents with the Division of Corporations (FL). The filing fee for the articles of organization is $125, which includes: • $100 for the articles of organization. • $25 for the designation of registered agent. (§ 605.0213(2), (7), Fla. Stat.) Professional Limited Liability Company One or more professionals may form, or cause to be formed, a professional LLC (PLLC) under the Professional Service Corporation and Limited Liability Company Act (PSLLCA) (§§ 621.01 et seq., Fla. Stat.) for the sole and specific purpose of rendering the professional service that the professionals are duly licensed or otherwise legally authorized to practice (§ 621.03(3), Fla. Stat.). Only other PLLCs, professional corporations, or individuals who are licensed or otherwise legally authorized to render the same professional service for which the PLLC was formed can be members of the PLLC (§ 621.09(2), Fla. Stat.). A PLLC is formed by filing articles of organization under the RLLCA (§§ 605.0201(4) and 621.13(2), Fla. Stat.). If the RLLCA conflicts with the PSLLCA, the PSLLCA governs the PLLC (§ 621.13(2), Fla. Stat.). Professional services include any type of personal service to the public that requires licensure or other legal authorization. Examples of professional services under the PSLLCA are personal services rendered by accountants, physicians, dentists, architects, veterinarians, attorneys and life insurance agents. (§ 621.03(1), Fla. Stat.) © 2019 Thomson Reuters. No claim to original U.S. Government Works. 7 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) Operating Agreement The operating agreement defines the LLC’s management structure, describes how the LLC’s profits are allocated and distributed, and sets out the agreements among the LLC’s members. It is similar to a combination of a corporation’s bylaws and a typical shareholders’ agreement. For more information on operating agreements and their principal provisions, see Practice Note, LLC Agreement Commentary. When preparing the operating agreement, parties should consider: • The rights of members. The operating agreement should spell out a member’s aggregate rights in the LLC, including the right to: • share in the LLC’s profits and losses; • receive distributions from the LLC; and • vote and participate in the LLC’s management. • Whether the LLC will have multiple classes of membership interests. With the flexible capital structure of an LLC, classes of membership interests can be created which include: • non-voting interests; • non-economic interests; • convertible interests; • income interests; or • profit interests. • The management of the LLC. Unless otherwise specified in the articles of organization or operating agreement, management is vested in the members (§ 605.0407(1), Fla. Stat.). An LLC may be: • member-managed, which is the management structure of most small business LLCs, with each member typically having the inherent authority to act on behalf of the LLC and execute contracts; or • manager-managed, which is generally more appropriate where there are passive members in the LLC (for example, investors who are not actively involved in the direct management or day-to-day activities of the LLC), with managers governing the LLC in a manner similar to a corporation’s board of directors. • In either case, the operating agreement should specify rules and procedures for members and managers to follow when managing the LLC. • For further information on the distinctions between manager-managed and member–managed LLCs, see Standard Document, Operating Agreement (Single Member) (FL): Drafting Note: Management. • Initial capital contributions. The operating agreement should state how an initial capital contribution will be made, whether by cash, tangible or intangible property, services rendered, promissory notes, or other obligations (§ 605.0402, Fla. Stat.). The operating agreement may also address a member’s liability or penalty for failing to make a contribution (§ 605.0403(5), Fla. Stat.). The default rule under the RLLCA, unless eliminated or varied by the operating agreement, © 2019 Thomson Reuters. No claim to original U.S. Government Works. 8 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) however, is that a person can become a member without making or being obligated to make a contribution to the LLC (§§ 605.0105(2) and 605.0401(4), Fla. Stat.). The operating agreement should specify if all, or just certain, members are required to make an initial contribution and the form and amount of that initial contribution. • The allocation of profits, losses, and distributions. The operating agreement should specify how profits, losses, and distributions are allocated among the members. Otherwise, the allocation is based on the agreed value of each member’s contributions to the LLC as stated in the LLC’s records (§ 605.0404(1), (5), Fla. Stat.). • The admission of new members and the transfer of membership interests. The operating agreement should specify the terms and conditions of admitting new members and any transfer restrictions on the membership interests (§§ 605.0401(3)(a) and 605.0502(6), Fla. Stat.). For a discussion of potential transfer restrictions, see Transfer Restrictions and Buy-Sell Rights. • The dissolution and winding up of the LLC. The operating agreement can specify events or circumstances that cause dissolution (§ 605.0701(1), Fla. Stat.). The RLLCA has default rules to determine who winds up an LLC’s affairs after dissolution, but the operating agreement can vary these default rules unless judicial supervision of the winding up is ordered (including the court-ordered appointment of a person to wind up the LLC) (§§ 605.0105(3)(j) and 605.0709(5), Fla. Stat.). The operating agreement also cannot vary certain other statutory requirements for winding up the LLC’s business, activities, and affairs (§§ 605.0105(3)(j) and 605.0709(1), (2)(a), Fla. Stat.). For more consideration of the above topics, see Operating Agreement Checklist (FL). A Florida LLC, regardless of the number of members, is not required to have a written operating agreement (§ 605.0201(4), Fla. Stat.). Nevertheless, an operating agreement is generally used to govern: • The relations among the members and between the members and the LLC. • The rights and duties of the LLC’s manager or managers. • The LLC’s activities and affairs and the conduct of those activities and affairs. • The means and conditions for amending the operating agreement. (§ 605.0105(1), Fla. Stat.) Most of the RLLCA’s provisions are default provisions, meaning they only apply if the applicable subject is not otherwise addressed by an operating agreement. If an operating agreement covers one of the matters set out above, it supersedes the RLLCA’s default rules. (§ 605.0105(2), Fla. Stat.) However, the following RLLCA provisions that cannot be varied by the operating agreement: • Vary an LLC’s capacity to sue and be sued in its own name (§ 605.0109, Fla. Stat.). • Apply any law other than Florida law to: • the LLC’s internal affairs; or • a member’s or manager’s liability for the LLC’s debts, obligations, or other liabilities. • (§ 605.0104, Fla. Stat.) • Vary the Florida Act’s requirement, procedures, or other provisions on: • registered agents; or © 2019 Thomson Reuters. No claim to original U.S. Government Works. 9 Massie, Raymond 6/6/2019 For Educational Use Only Forming and Organizing an LLC (FL), Practical Law Practice Note w-000-1428 (2018) • the DOC, including those related to documents that must be filed. • Vary provisions related to signing and filing on behalf of the LLC under a judicial order (§ 605.0204, Fla. Stat.). • Eliminate the duty of loyalty or the duty of care except as otherwise provided by the Florida Act. For example, if the conduct does not involve bad faith, willful or intentional misconduct, or a knowing violation of law, the operating agreement may, if not manifestly unreasonable: • alter or eliminate aspects of the duty of loyalty; • identify activities that do not violate the duty of loyalty; • alter the duty of care (but may not permit any willful or intentional misconduct or a knowing violation of law); and • alter or eliminate any other fiduciary duty, such as common law duties of loyalty and care. • (§§ 605.0105(3)(g), (4)(c) and 605.04091, Fla. Stat.) • Eliminate the obligation of good faith and fair dealing (§ 605.04091, Fla. Stat.), except the operating agreement may prescribe standards by which performance will be measured, if not manifestly unreasonable. • Relieve or exonerate liability for conduct involving bad faith, willful or intentional misconduct, or a knowing violation of law. • Unreasonably restrict the member’s or manager’s duties and rights to inspect and copy LLC records (§ 605.0410, Fla. Stat.), except the operating agreement may: • impose reasonable restrictions on the availability and use of information; and • define appropriate remedies (including liquidated damages) for any breach of those restrictions. • Vary the grounds for judicial dissolution (§ 605.0702, Fla. Stat.). • Vary certain requirements for winding up the LLC’s business, activities, and affairs on dissolution, including: • discharging or making provision for the LLC’s debts, obligations, and other liabilities; • settling and closing the LLC’s activities and affairs; • distributing the LLC’s assets; and • conducting the wind up under judicial supervision, if applicable. • (§ 605.0709, Fla. Stat.) • Unreasonably restrict a member’s right to maintain a direct or derivative action (§§ 605.0801 to 605.0806, ...
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