Q. A partner and I are planning to open a small publishing house, and we have five people who are willing to invest money for shares, so we are planning to open as a S Corp. I have several questions about having shareholders, including: Do we have to have a Board of Directors?
What kind of powers do directors actually have? What exactly should we cover in our bylaws if we incorporate? Should we just get stock bylaws we can order somewhere or should they be specific to our company? If we decide to have shareholders, do we need Buy-Sell Agreements? What should a Buy-Sell agreement cover? If we decide not to take shareholders and have a partnership, what type of Buy-Sell Agreement should we have and why? If we do this business as a S Corp, must we keep Corporate Book, and if so what must be included in the books and how, when, and why must the books be updated?
First, opening a small business is exciting; however, for the untrained and weary, it is very scary. Most owners just focus on making the widgets or providing the service and forget all the behind the scenes things that must be done or worse yet, listen to friends who are not qualified. In your question, you focus on an S Corporation like that is a separate entity recognized by the Texas Secretary of State. You are partly right.
An “S” corporation is not a matter of state corporate law but rather a federal tax election. A for-profit corporation elects to be taxed as an “S” corporation by filing an election with the Internal Revenue Service within a certain time period. In the eyes of the Texas Secretary of State all Texas corporations are the same. The IRS and/or competent tax counsel will be able to assist with the decision to be taxed as an “S” corporation and the requirements for filing the election. Setting up an S corporation is not a matter with which the Secretary of State will assist.
Do we have to have a Board of Directors?
No. As you know, a corporation is a legal person with limited liability, centralized management, perpetual duration and ease of ownership transferability. Owners of a corporation are called shareholders and those who manage the corporation are called directors. However, Texas state law does allow for shareholders to enter into a shareholder agreement to eliminate directors and manage the corporation. For a small business this may be advantageous; however, if you ever want to sell stock to a shareholder, it is likely that shareholder will not want to participate in the management of the corporation.
What kind of powers do directors actually have?
Directors have as much power as the shareholders of the corporation provide and as allowed by law. Typically the powers are found in the corporation’s bylaws and are responsible for the day to day management of the company. An example of the “Powers” section of my standard bylaws looks as follows:
The Directors shall act only as a board and an individual Director shall have no power as such. All corporate powers of the corporation shall be exercised by, or under the authority of, and the business and affairs of the corporation shall be controlled by the Board of Directors, subject, however, to such limitations as are imposed by law, the Articles of Incorporation or these Bylaws as to actions to be authorized or approved by the shareholders. The Board of Directors may, by contract or otherwise, give general or limited or special power and authority to the officers and employees of the corporation to transact the general business, or any special business, of the corporation, and may give powers of attorney to agents of the corporation to transact any special business requiring such authorization.
What exactly should we cover in our bylaws if we incorporate? Should we just get stock bylaws we can order somewhere or should they be specific to our company?
Many forms exist in this electronic age that tempt the small business owner to adopt and place in the new corporate book. However, with any form, it is simply for the average company and contains no customization for your entity. Bylaws address important items like when, where and how often shareholder meetings occur, quorum, voting, share issuance, powers of directors and officers and share certificates. Clearly, these items while not important at the corporation’s outset become very important when the company grows and new shareholders enter the company. Getting solid reliable bylaws in place will ease your mind down the road.
If we decide to have shareholders, do we need Buy-Sell Agreements? What should a Buy-Sell agreement cover?
A buy-sell agreement is important to have in a corporation as it addresses what happens to the shareholder’s shares upon the occurrence of some event (voluntary sale, death, divorce). So many times in a lawyers practice, he/she will get a phone call from someone that says they are in a corporation and another shareholder is divorcing. The remaining shareholders don’t want the spouse to own any of the corporation or be involved in any of the management of the corporation.
Texas adopts the Spanish tradition of community property as so long as the property was acquired during the marriage, the shares are property of the community. During the divorce, the Judge will issue a just and right division of the assets which may include some of the shares going to the spouse (of course to the objection of the remaining shareholders). To solve this problem, the shareholders and their spouses will execute a buy-sell agreement that addresses this issue. It is always best to address this issue before it becomes an issue.
Also, most buy-sell agreements will offer the shares back to the company upon the death or divorce of one of the shareholders utilizing a predetermined procedure set forth in the buy-sell agreement. This is a complicated yet smart document to have in place immediately upon chartering your new corporation.
If we do this business as a S Corp, must we keep Corporate Book, and if so what must be included in the books and how, when, and why must the books be updated?
Every Texas Corporation must keep records traditionally in a corporate book of some sort (it does not have to be a fancy leather bound book…it can be a three ring binder). The corporation’s bylaws will dictate how often and where the shareholders will meet as well as the directors. The shareholder’s meeting minutes will go in the corporate book as well as some of the Board of Director’s minutes. That issue will be addressed in the corporation’s bylaws. Typically, though, you should remember to place minutes, resolutions, notice waivers or consents without meeting documents into the corporate book. This whole process we affectionately call “stuffing the corporate book”.
Failure to stuff the corporate book, may let an eager Plaintiff’s lawyer “pierce the corporate veil” in the event of a lawsuit.
Editor's note: The information in this column is not intended as legal advice but to provide a general understanding of the law. Readers with legal problems, including those whose questions are addressed here, should consult attorneys for advice on their particular circumstances.
