Common pitfalls to self-incorporation
Oftentimes, we are engaged to clean up the corporate records of an early-stage company that decided to self-incorporate to save on legal costs.
“It is only a couple hundred dollars to incorporate; I will just do it myself,” a client may think.
The problem is that, while that client is not wrong that incorporating and getting a certificate of incorporation is very easy to do, clients will often stop here and miss a number of key considerations that could end up costing more in legal fees down the road.
This blog post sets out some of the common issues we encounter when companies self-incorporate and why it is best practice from a compliance and cost perspective to engage legal counsel from the outset.
Failure to complete the incorporation document process
There is more to incorporation than simply obtaining a certificate of incorporation from the applicable regulatory authority.
The following are items that are most commonly missed when clients self-incorporate:
- The company should have a corporate minute book, which is a binder or electronic record containing all of the corporation’s corporate records and is required by the applicable corporate statute to be located at the company’s registered office.
- The company should consider the rights, privileges, restrictions and conditions of all authorized shares and whether there should be multiple classes of shares where the rights, privileges, restrictions and conditions differ.
- It is best practice for the shareholders and directors of the company to approve a set of corporate by-laws that govern how the company’s business is to be conducted, including processes for:
- conducting meetings of the directors of the company
- conducting meetings of the shareholders of the company
- executing instruments/documents on behalf of the company
- setting out the banking arrangements of the company
- setting out the requirements for the borrowing of funds on behalf of the company
- setting out the rights and obligations of officers of the company
- The company should have a resolution of the shareholders of the company to elect the directors of the company, appoint an accountant, waive the requirement of or appoint an auditor and confirm the approval of the by-laws.
- The company should have a resolution of the first director(s) to approve the by-laws, the issuance of the shares to the initial shareholders, the number of directors and the form of share certificate. In most jurisdictions, directors need to consent to act as directors in writing, and prior to signing such consent, the directors should ensure that they may be elected as directors on the basis of any restrictions set out in the applicable statute. Accordingly, if applicable, each director should execute a written consent prior to being elected as a director.
- The company should have a resolution of the directors appointing the officers of the company and setting the financial year end of the company.
- The company should have each shareholder execute a subscription document for their shares, including the date of issuance, class of share and price paid for those shares.
- Each shareholder should have an executed and properly issued share certificate evidencing their ownership interest and a share register documenting the shareholdings of the company. Those share certificates should include the appropriate restrictive legends, where applicable, including reference to any unanimous shareholders agreements.
- Once the shareholders, directors and officers are recorded in the minute book, as applicable in each jurisdiction, companies will need to file a notice of this information to the applicable governmental authorities.
While it is possible in the future to bring forward any omissions or inconsistencies between the corporate records and the actual history of the company, it is best practice to try to ensure compliance with corporate laws from the outset. There is no guarantee that all of the directors and officers who were elected and appointed at the time will be available and/or willing to sign the required documents to remedy any omissions or inconsistencies in the future.
Moreover, by engaging legal counsel from the outset, the shareholders and directors will have greater confidence in compliance with respect to applicable laws at the time of incorporation and into the future which may allow them to capitalize on future opportunities, including potential investments.
Losing private issuer status
As we explain in our previous article, a company may lose its status as a private issuer and thereby not issue securities using the private issuer exemption in National Instrument 45-106 – Prospectus Exemptions, if there are no restrictions on the transfer of shares. Accordingly, companies will need to ensure that their articles of incorporation – or a shareholders agreement, if applicable – contain that restriction.
Failure to complete annual filings
In accordance with applicable corporate laws, companies are required to make annual corporate filings with their applicable government authority. When handling these directly, companies often miss one or several annual corporate filings. If this persists over time, companies will not only be in breach of applicable corporate law but could be subject to penalties and be dissolved.
A company that engages a law firm to maintain their minute book has the advantage of being prompted to make their annual filings on a timely basis.
Failure to comply with annual meeting and approval requirements
Under applicable corporate laws, companies are required to hold an annual shareholders meeting or execute a unanimous written resolution in lieu thereof.
If a shareholder meeting is held, a company will need to be very mindful of notice and quorum requirements in accordance with their applicable corporate statute and by-laws and must also include the minutes of such meeting within the company’s minute book.
If the company instead executes a unanimous written resolution signed by all its shareholders, it should also be sure to include that resolution in their corporate minute book. The directors of a company are also required to approve the financial statements of that company on an annual-basis, by holding a meeting of the directors or by executing a unanimous written resolution in lieu thereof.
Failure to adopt a shareholders agreement
We encourage companies to consider whether a unanimous shareholders agreement should be adopted at the commencement of a company. Without a shareholders agreement in place, it can be very challenging to, among other things, remove founding shareholders from a company that are no longer participating in the business.
To obtain a greater understanding on the need for a unanimous shareholder agreement, see our recent article on creating an effective shareholder agreement.
Investment readiness
This brings us to the topic of investment readiness. A company that is interested in seeking investment from outside investors will want to ensure that all the points of above are addressed prior to investors reviewing their corporate records.
For more information on how a company can get investment ready, see our previous article on investment readiness.
There are several pitfalls to self-incorporation that can be avoided by having qualified legal involved in your incorporation process. By engaging legal counsel from the outset, you may save valuable time and money that may be incurred later.
Should you wish to discuss incorporation of a company or a review of your corporate records in the context of applicable laws, please contact the authors.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.
