Articles of Incorporation – 6 Mistakes that Will Cost You!
A company’s Articles of Incorporation are also known as its Certificate of Formation, or Articles or Organization. Its is among the simplest and first documents to file to create a business entity. Articles of Incorporation can be done without any special expertise. They can be done quickly for little money. Simplicity and ease are the reasons huge mistakes are commonly made.
- Do you intend to expand your business so it becomes large?
- Do you intend for your business to have such success that it is worth many millions of dollars?
You will need expert legal advice from its inception to accomplish those two goals. This article explains the five most glaring mistakes made in Articles of Incorporation.
MISTAKES IN ENTITY FORMATION
Mistake #1 – Not Using a Lawyer
This only seems like self-serving advice. Articles of Incorporation are like a precision dive. Anyone can jump in a pool, but if you are going to be judged in the future regarding how you get into the pool, do it right. Businesses vary. Each has its unique combination of vision, industry, location, employees, and other circumstances. It is the job of the business lawyer to understand the legal and industry environment, learn your business, and then combine his knowledge and experience to put the first steps of the business on the right path. This process is not expensive for Articles of Incorporation. They are permanent public documents. Your business will be judged by them, and that judgement will matter.
The ”Corporate Kit”
The Articles of Incorporation are part of what is often referred to as the “Corporate Kit,” meaning part of the package to form the business correctly. Corporate kits usually contain:
- Customize Articles of Incorporation
- Formal Entity Records Book
- Corporate By-Laws
- Corporate Minutes
- Stock Certificates
- Direct Legal, business, credit and tax advice
Investing in a competent industry specific business lawyer is money well spent.
Mistake #2 – Choosing the Wrong Type of Business Entity
There are important differences between LLC, single member LLC, S-Corp, C-Corp, and Non-Profit entities. What may be a convenient corporate entity type may prevent your business from capitalizing on important advantages later.
Mistakes in corporate formation may not be fixable without significant time and money cost. There are advantages, disadvantages, and options depending upon your industry, business activities, unique profit opportunities, unique risks, and future business plans. Choosing the wrong entity type can cause issues with:
- Control over owner decision making
- Tax liability
- Raising capital investments
- Limited legal liability
- Business location – Expanding into new markets
- Business scope – Expanding into new areas of profit
- Anonymity – Privacy or Owners
Your unique opportunities and risks need to be compared with the advantages disadvantages, opportunities and limitations of the various entity types. Choosing the wrong entity type early can cause great time, money, and opportunity costs later.
Mistake #3 – Choosing the Wrong Registered Agent
Registered Agent as a Job
It is great that your nephew, or spouse’s sibling needs a job. However, the Registered Agent of your business is the wrong opportunity to offer. The job of the registered agent is to receive filings, tax notices, court notices, official documents. Choosing the wrong person may lead to problems, like:
- Privacy breaches. (No attorney client privilege. May voluntarily disclose.)
- Defaults in lawsuits (Failing to recognize and pass along important documents)
- Bad standing with governments and businesses (having a flawed personal reputation or criminal record)
A registered agent needs to consistently, dutifully perform the task without errors. What your business does not find out about can hurt it.
Registered Agent Reputation and Record
The registered agent is the public face of the business. The agent is occasionally the only actual person identified in the Articles of Incorporation. You should expect your business to be investigated at some point. This investigation may be for a potential sale, merger, or acquisition. This investigation may be an important customer evaluating your business for a great opportunity. This investigation may be a government employee considering business culpability. What will an investigation into your registered agent find? You want a look into your registered agent to improve, not detract from your reputation.
How to Choose the Right Registered Agent
Many professional entities and law firms offer the services of registered agent for a reasonable cost. The non-law firm entities are popular because of their consistent performance and low cost. Law firm entities are popular because they provide the added benefits of advanced legal scrutiny and attorney client privilege, and their cost is not particularly higher than the non-law firm entities. Either way, the choice of a Registered Agent should be intentional and informed.
Failure to have protective agreements
- Custom Articles of Incorporation
- Custom Operating agreements
- Indemnification agreements. Shield directors and officers from personal liability and costs for actions taken on behalf of the corporation.
- Non-disclosure agreements
- Non-compete Agreements
- Proprietary Information and Invention Assignment Agreements
- Shareholder’s Restrictive Agreement. Outlines their obligations and restrictions to each other.
- Shareholder divorce protection clauses. Right of first refusal.
Mistake #4 –Think More About the Corporation Name
Forgettable Brand Identity
Brand identity is a critical business asset. Some business owners choose a business name that sounds serious, but is not the actual name of the business they intend to put to the public. If you want people who are looking for your business to be able to find you, use a name they will notice. A bland, forgettable corporate lingo name may not be appropriate for your marketing plan.
Privacy Loss
Other business owners highly value their privacy and want their business information to remain as anonymous as possible. Yet, they put their public name on all filings, like the Articles of Incorporation. They are simply making it easy for their competitors, and others who wish to track them.
Trademark Protection Loss
A corporate name can typically be created and used in any jurisdiction that does not yet have an identical filing. Thus, what if you wish to do business as “Crypto Blockchain Wallet Company” and build your reputation around that name, but use a different name on your Articles of Incorporation or Certificate of Formation? A competitor or “knock off” business can then file under your “Crypto Blockchain Wallet Company” name. What claim do you have when your competitor advertises to your customers under its official name? You may wish to safeguard your business name through your Articles of Incorporation.
Mistake #5 – Electing Member Managed versus Manager Managed Control
Some jurisdictions require businesses to disclose the type of owner decision-making control the entity will use. These Certificate of Formation disclosure broadly break down the options between:
- Member Managed, and
- Manager Managed.
The term “member” is synonymous with “owner” in the LLC context. The members are the persons who own the equity (stock or units) of the business entity. In a member managed entity, each member has decision making authority over company decisions. That owner authority cannot be taken away by employees or executives. Many startup founders like this degree of control and elect “Member Managed” in their Articles of Incorporation, Certificate of Formation, and Operating Agreements.
Manager managed business entities delegate decision making authority from the owners to executives. Thus, decision making authority lies not with the owners (members) of the business, but rather with those who have been delegated the authority … the Managers.
A Jack of All Trades Master of None
The largest advantage of any business has been specialization of skills, and coordination of activities. Company’s crave clarity. The best most efficient businesses match up people’s talents and experience with their best role in the organization. What goes for employees should also go with management. Executive decisions should be made by the person with the best qualities to make those decisions. However, in a Member Managed corporation, any owner of equity in the company can make decisions, regardless of whether there is a fit between the decision and their experience.
Vitalik Buterin is the primary founder of Ethereum. He is a computer programmer, cryptologist, and the son of a computer scientist. Mr. Buterin would be a perfect choice for creative decision making for a blockchain application business. However, Vitalik would likely be a poor choice to lead a corporate athletic team.
Boss Shopping
Decision making authority is also not divided in member managed companies. This means that any member can make business decisions. This can cause several problems. First, employees will quickly learn who is likely to decide in a particular way given the circumstances. Employees will be able to direct questions and decisions to the owner (member) they expect is most likely to agree with them.
Too Many Cooks in the Kitchen
Second, one member (owner) may not agree with the decision of another member (owner). With all members having authority to decide, conflicts are more likely to arise with the overlapping authority granted by member managed organizations.
The Company Storm Crow
Third, some decisions may be put off, or not made, at all in member managed entities. We all have experienced problems with which we just did not want to deal. In a member managed organization, since it is every member’s responsibility, it is also no member’s responsibility (in particular). This means someone can always state (I thought that other person was going to deal with it). Worse, some members (owners) may always delegate unpopular decisions to a particular member, making them the company “Storm Crow.” This will lead to resentment, at best.
Merger, Acquisition, & Sale Woes
Many companies expand to the point where venture capital investors wish to give money to the owners for a share of the company equity. This results in a large payout to owners, which they like. This results in a large infusion of money into the organization, giving it capital to expand and grow. This is also good. However, consider what is given in exchange for the money. The investors are now part owners of the company. This means they are “members” and have decision making authority that is unchecked in a member managed company.
Divorce!
Similar new-owner problems can arise should a divorce occur. The former spouse of an owner may gain a share of the ownership of the company and marital property in a divorce. This makes your business partner’s ex-spouse your new business partner, and that spouse has decision making authority difficult to limit.
Death!!
An owner may die. That owner’s heirs may inherit the owner’s business equity interest. Those heirs, whom you may not know, and who may know nothing about the business, suddenly are managers with authority.
All these issues can be resolved in the Articles of Incorporation, Certificate of Formation, and Operating Agreement by electing Manager Managed control. Remember, if you want authority, you can still have yourself named a President.
Mistake #6 – Business Purpose – Poorly Thought Out
Most jurisdictions require a company to provide a written statement of its purpose as part of its Articles of Incorporation. The purpose statement is notice to the government explaining what business activities the entity is requesting legal approval to conduct. It is not a business vision. The “Purpose” is not a mission statement. It is not meant to attract customers. The purpose statement is not to inspire employees.
These statements break down to several aspects, which include:
- Why the entity exists
- The Legal purpose of the entity
- What activities the government can expect from the entity
The Generic “Dial It In” Purpose Statement
Most businesses utilize “catch-all” business purposes statements, like “The purpose of this limited liability company is to engage in any lawful activity for which limited liability companies may be formed in this State.” Catch-all business purposes statements work, but are rather unhelpful in distinguishing a company.
The Too-Specific Purpose Statement
A legal nuance businesses must keep in mind is that its owners, executives, agents, and employees are barred from activities that conflict with the business purpose statement. People can be held personally responsible for their decisions, actions, or omissions that do not fit within the Purpose statement.
What is more, businesses often evolve. What may initially be a crypto liquidity mining (yield farming) business may morph into a NFT (ERC 721) blockchain promotion business, as opportunities arise. The business purpose statement must take into account changing business circumstances to allow room for evolution of business activity.
Other Major Mistakes
There are other Mistakes with Articles of Incorporation. They are not “fleshed out” in this article as the Top 6, because of their limited application (only problems for some types of businesses. Other errors may be less frequent. They may be correctable. Other errors include:
- Failing to spell out what kinds shares will be issued
- Failing to state what voting rights shareholders will have.
- Stating how shareholders will be paid.
- Multiple modifications to the Articles.
- Failing to provide for many share types of classes, unlimited capital, allow for a range of directors.
Contact us at Whale.Law if you expect your business to achieve a level of success that professional help will increase its value and better achieve its goals.
Author:
Juris Doctor
Trial Lawyer
5 Operating Agreement Mistakes that Will Ruin Your Business
One problem is the business managers do not know what is in the operating agreement; or worse, they do not know what the operating agreement is missing. It is common for businesses to get their operating agreement in three ways:
Imagine a small but growing crypto startup wants to create blockchain infrastructure bridges so that one crypto blockchain can efficiently transfer tokens to other crypto blockchains. In crypto businesses, there are many specialized experts. There are people skilled in one field, and not as skilled in other fields. Business progress is uneven. Business challenges can be overcome quickly, or get bogged down for months costing millions.
A blockchain legal consultant may have a great grasp of international law, SEC registration, and contracts to secret confidential information. It would be a mistake for a blockchain lawyer to have responsibilities and authority to manage the programming of C++, Python, and JavaScript, even if the blockchain lawyer is an owner.
An operating agreement that mandates Manager managed operations allows skills, experience, and passion to be paired with the best position within the business. It avoids the two problems of:
These events can cause owners to be forced to be business partners with persons they do not know, or do not like.
Author:
It is common for crypto / blockchain employees to start employment at one blockchain business, then later leave to work for themselves, or a competitor. Employment turnover exacerbates business secret risks for every crypto business’ confidential information.
Stealing employees are not taking crypto confidential information for curiosity. Your stolen confidential information is being “sold” to your competitors as part of your former employee’s “employment package.”
Are you a Founder or Executive? Watch Out!
Taking business secrets and confidential information is a breach of contract when the employee has signed an effective 
Non-compete agreements are common areas of top-down abuse. 
Competition between businesses in the crypto blockchain ecosystem is fierce. Your competitive advantage may be only slight compared to other crypto businesses.
Bad News: It may be that you should not want to disclose your confidential business information to this other party; whatsoever, irrespective of how enticing the prospects. The sooner you come to this realization, the better.
A pre NDA investigation is how this information is discovered so that it may be put to use.
The point of having a non-disclosure agreement is for it to actually protect your business secrets.
David vs. Goliath – Large organizations tend to disregard small businesses. This may result from the diffusion of responsibility within the larger business. This may result from a large entity “profit at all costs” culture. Whatever the root cause, there has always been a tradition of larger, more powerful parties profiting at the expense of the smaller party. This tradition persists to this day.
It is an industry practice for contracts with one title to actually contain provisions, clauses, and mandates that do not fit within the boundaries of the contract title. It is also an industry practice for contract terms in a later contract to invalidate provisions from earlier contracts. This “trick” may be expressly spelled out in a paragraph. It may be hidden within an “entirety” clause, which is a clause stating the present contract between the parties is the whole agreement and all previous agreements are rescinded and invalid (boilerplate language with a punch!)
Know all the categories of people to whom you will be discussing in advance. Try not to miss anyone.
Reality Check: Do not expect a venture capital or other investor to sign a confidentiality agreement or a non-disclosure agreement. First, they feel that if it is necessary for you to disclose your confidential business secrets just to earn an investor, then the information and documents really are not “secrets” and it is not worth their money. Second, investors, especially venture capital investors see many proposals. They cannot be put in the position of having so many contracts “lording over them” as it creates a legal jungle. Luckily, the business risk of an investor or other venture capitalist disclosing your confidential business secrets in the absence of a non-disclosure agreement is small. If a venture capitalist had a reputation of disclosing to competitors, that investor would not be in business for long!
Length of relationship time is a particular concern for non-disclosure agreements. Each non-disclosure agreement will include a time period where the duty not to disclose ends. You cannot simply draft a non-disclosure agreement that exists in perpetuity and never ends. A judge is likely to declare a never ending timeline unreasonable, and will either strike the entire agreement (very bad!) or impose a time period the judge deems reasonable, which may or may not harm your business.
Explore whether the party to whom you are going to share your confidential information will share this information (intentionally or unwittingly) with persons or entities not a party to your non-disclosure agreement. Examples include:
Make a list of the various categories of business secrets and confidential information you must protect. Make your list specific. Make your list complete. This is important for two reasons.
First, the other party to the contract will be unable to figure out what they are supposed to keep secret and what they can disclose. So, though well meaning, the attorneys who drafted those non-disclosure agreements have put their clients in an untenable position.
There are exceptions when confidential information must be disclosed. Make sure your non-disclosure agreement carves out these exceptions to your definition of business secrets so that the lack of a carve out does not spoil other portions of the non-disclosure agreement. These include:
To address these risks, make sure your NDA lawyer drafts a specific conspicuous clause in the non-disclosure agreement that the other party has a duty to provide notice of any legal obligation to disclose. There should also be written in a time period to raise objections for a legal process requiring disclosure.
There are economic realities that harm businesses through the disclosure of confidential business information but still prevent a practical remedy because of the time and cost of litigation. Make sure you discuss various remedy provisions within the non-disclosure agreement. These include:
There are rules, known as “Choice of Laws” provisions and “Venue” statutes that determine the physical location of any dispute. Venue can be the location of the parties. It can be the location of where the “bad act” occurred. It can be the location of where the damage occurred.
Contract laws can permit arbitration or mandate any disputes be decided by a court of law. Prepare to discuss in advance the benefits and detriments of arbitration with your non-disclosure agreement attorney so you may decide whether to include an arbitration provision.
Few relationships last forever. It is likely your business relationship with this other entity will at some point end. At that time, the issue will arise. What should be done with the confidential information shared between the parties? Choices include:
Watch out for proposed provisions that may result in a transfer of ownership of proprietary information. For example, a provision that a party disclosing a document will own any and all information in that document may give the counterparty an argument that it owns your information because it disclosed a document containing your information to you. The NDA should address which party will own any intellectual property derived from information disclosed by the parties (assuming the NDA contemplates the creation of intellectual property).
