What is the importance of year-end corporate governance work? I know. I can see and hear it now: most businesspeople just roll their eyes and ask, “why do I have to go through this hassle?” What is the purpose of a corporate entity in the first place? What is corporate governance and compliance and why should this issue be on your calendar this month if it’s not already?
Let’s review the reason you have a business entity or corporation. The reason to establish an LLC, S Corporation or C Corporation, is to separate the business owner(s) personal assets and interests from the contingent liabilities of the business entity. If corporate liability or litigation arises the sole avenue for the recovery of financial damages rests with the assets of the business entity itself (unless the owners have signed personally for the debt as well as officers of the company).
This important distinction between the owners of the company and the company itself is know as the “corporate veil.” In the event of a judgment, creditors want access to every asset available. In many cases, the owners of the business are actually worth much more than the business itself. Therefore, one of the first steps a capable attorney will take is an attempt to “pierce” the corporate veil so that collections may pursue the owners of the business as well as the company itself.
Corporate governance and compliance not only helps to protect the corporate veil and the legal and financial separation between a business and its owners, but it helps to reduce the likelihood of disputes or lawsuits as well.
We Aren’t Really at Risk for a Lawsuit Are We?
One of the biggest and most common corporate crises we encounter in businesses facing litigation is that the corporate documents are often incomplete. In many cases, entrepreneurs go to a website to download “corporate documents’ to create their own entity. Unfortunately, many business professionals don’t understand the comprehensive documents and associated clauses and provisions required to properly create and structure an entity. When a corporate entity is not fully formed, it’s quite easy for an experienced litigator to pierce the corporate veil and purse the funds and assets of its owners.
You may not face litigation from outside the company, but if your company is profitable, it is very likely an internal dispute could be in the cards. Liability may arise out of arguments between owners, members or shareholders. If there are multiple owners or investors with an interest in your company the likelihood of a business dispute or lawsuit greatly increases. You might be amazed at the number of business lawsuits based upon internal disputes over money between the company’s owners.
What is the Essence of Corporate Governance?
The essence of year-end corporate governance is taking action to protect the corporate veil by ensuring regular update of important documents such as the corporate articles and bylaws and how they relate to either the operating agreement or shareholders’ agreement. The corporate articles and bylaws generally govern how the company is organized and operated. The operating agreement or shareholders’ agreement usually focuses on the relationship between the owners of the business, issues of voting and control as well as distribution of income and/or distributions.
Therefore, the first focus of year-end corporate governance work is the corporate documents themselves. In addition to the articles of incorporation and bylaws, the operating agreement or shareholders agreement there’s often a purchase and sale agreement between the entity and the member(s) or the shareholder(s). There might be stock or membership agreements, stock or membership ledgers, as well as the minutes for either members or for shareholders, as well as directors and/or officers.
It is important to verify that we look for discrepancies between all the corporate documents and to update them based upon anything that might have come up in the past year. One also has to ensure that the corporate documents have been properly submitted to the Secretary of State and that the Secretary of State acknowledges the filings. Has the business paid annual California franchise fees?
The failure to update corporate documents and pay California franchise fees can result in suspension of the corporate entity by the Secretary of State. If a business is suspended it cannot legally do business, bring an action or defend your corporation in court or even legally close or dissolve a company. Obviously, suspension eliminates the protections of the corporate veil and creates a complex new series of serious challenges.
Corporate Governance Also Addresses “Change”
We all know change is a constant in any equation, therefore, corporate documents are very much living and breathing documents. Corporate governance is about addressing the changes of the past year and what may be changing in the coming year.
One must also consider what lies ahead in the coming year. Succession plans should be updated (or created if they do not currently exist). Are you considering any asset purchase, merger or acquisition? Has the company grown? Do we need to bring in additional management or skilled personnel?
Does the company need to attract investors or raise operating capital? The corporate documents establish how membership or ownership can be increased in an entity. How will additional shares or membership interests be distributed to individuals that come aboard in the future?
Any experienced investor who is thinking about taking a position in an entity will investigate the underlying corporate documents. This is also true if the business is to be sold or if the corporation becomes involved in any substantial transaction, merger or acquisition.
How Often Should a Company Attend to Corporate Governance?
Ideally, corporate governance is an ongoing process and discipline throughout the year. Unfortunately, it’s one of those corporate duties that tends to be ignored or put off, hence the importance of year-end corporate compliance work. Corporate governance is required for corporations in California (even if they are not technically California corporations).
The corporate entity must attend to recording shareholders’ minutes and/or officer/directors’ minutes yearly. It is advisable for LLCs and their members to have a membership meeting as well as manager meetings so that members remain in sync with each other, as well as where the company is going and how it’s going to get there.
The minutes should look back and recognize what it is that’s occurring as well as the concurrence and the agreement among the individuals who own or have invested in the company. In most cases, the minutes are a reflection of what it is what it is that has been agreed to in the past, any changes required for the present and where the company and its owners/managers plan to take the business in the future.
Are you concerned about year-end corporate governance and compliance? Are you a member or shareholder in a corporation who is concerned about protecting the corporate veil? We can help to answer your questions and ensure your corporation remains in good standing with the State of California while doing everything possible to reduce the risk of an internal or external business dispute.
We invite you to learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.