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Top 5 Reasons To Use Restricted Stock Awards In Your Early Stage Startup

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Startups often use equity to help attract and retain talented workers.  This article outlines the differences and similarities of stock options and restricted stock awards and why most early stage startups that issue stock shortly after formation utilize restricted stock awards when compensating their workers. What are stock options? Stock options give employees the right… Read More

Startups often use equity to help attract and retain talented workers.  This article outlines the differences and similarities of stock options and restricted stock awards and why most early stage startups that issue stock shortly after formation utilize restricted stock awards when compensating their workers.

What are stock options?

Stock options give employees the right to buy a specific number of shares of the company at a specified price (the “strike price“) during a window of time.

What are restricted stock awards?

Restricted stock awards typically vest over time, usually over a four year period for employees and two years for advisors.

If the worker or the advisor leaves the company before all of the stock has vested, the company has the right to repurchase the unvested stock.

How are stock options and restricted stock awards similar?

Both stock options and restricted stock awards encourage loyalty to the company by incentivizing the worker to remain with the employer for at least a minimum period of time.

In addition, both provide an important tool to startups that may not have much cash to attract top talent.

Finally, both encourage the worker to increase the value of the company which creates a unity of interest between the worker and the employer.

How are stock options and restricted stock awards different?

One key difference is holders of restricted stock awards own their shares from the date of the stock grant.

In contrast, stock options provide the holder with the opportunity to purchase the stock in the future. In addition, stock options typically have an expiration date and the worker can only exercise their options during a specific window of time.

What are the benefits to stock options?

With stock options the worker is not out any money if the stock price does not rise because they can decide not to exercise the stock options.

That being said, for new startups the fair market value for shares is often only the par value of the shares. Thus the purchase price is typically very minimal.

Why are restricted stock awards often better than stock options for most early stage startups?

Each situation is unique, but most early stage startups use restricted stock awards rather than stock options for five reasons.

1.  No Need For a 409(a) Valuation

The board of directors is required to determine the fair market value of stock for both restricted stock and stock options.

The key difference is that fair market value for restricted stock awards is the fair market value of the stock when it is purchased. Shortly after formation the stock usually does not have much value, so this is often the par value of the stock.

In contrast, the valuation of stock options is typically done by a professional valuation company (a 409(a) valuation) and can cost thousands of dollars. If the company uses restricted stock awards, this money can instead be spent on the company’s other priorities. 

2.  Stock Options Could Become Worthless

Also, a stock option could become worthless.  For example, a stock option grant with a strike price of $10 has no value if the fair market value of the stock is later determined to be $8.  In contrast, if restricted stock is granted when the stock is trading at $10 and is later worth $8, the stock is still worth $8 and has only lost 20% of its value.

3.  Restricted Stock Awards Might Better Motivate Workers and Advisors

In addition, some workers and advisors might be better motivated with restricted stock than with stock options because workers will get shares of the stock regardless of whether its value increases.  In contrast, stock options are worthless if the value of the stock goes down or if the worker fails to exercise the stock option.

Restricted stock, therefore, might better motivate some workers and advisors to think and act like owners of the company, take a personal interest in the company, and be more focused on meeting the company’s objectives because they will obtain shares regardless of whether the stock price goes up or down.

In contrast, stock options might do less to instill a sense of ownership because the worker could invest years in the company only to find that the value of the stock has decreased and the options have no value. Because the value of the stock may not increase, the worker might not have the same amount of loyalty to the company as they would if they had been granted restricted stock.

4.  Immediately Start The Clock Running For The Lower Capital-Gains Rate

If the worker makes an 83(b) election, the income from the restricted stock grant will be recognized at the time of the stock ”transfer” – its purchase date – rather than when the stock vests. The reason this is important is if an 83(b) election is made, the long term capital gains holding period also begins on the purchase date of the restricted stock rather than when the stock vests.

5.  Workers May Be More Likely To Focus On The Long-Term Value Of The Company

Finally, a worker with stock options might be more motivated to increase the short term stock price so they can exercise their stock options. This may be to the detriment of the longer term growth of the company.

For all of these reasons, most early stage startups which issue stock shortly after formation use restricted stock awards instead of stock options as they often provide a superior method of compensating and motivating workers and advisors.

We typically see this switch to stock options being the preferred tool for motivating workers and advisors after the company has raised its Series A round. At that point, the fair market value of the stock has gone up and it is more expensive to purchase.

Please contact us at (415) 633-6841 or info@bendlawoffice.com to discuss whether restricted stock or stock options might be the best fit for your company.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Should Your California Professional Corporation Elect To Be Taxed As An S Corporation?

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Should your company elect to be taxed as an S corporation? In California, certain professions that require a state license are prohibited from forming a limited liability company or a traditional corporation and instead must incorporate as a professional corporation. By default, California professional corporations are taxed as C corporations. As a C corporation, your… Read More

Should your company elect to be taxed as an S corporation? In California, certain professions that require a state license are prohibited from forming a limited liability company or a traditional corporation and instead must incorporate as a professional corporation. By default, California professional corporations are taxed as C corporations. As a C corporation, your professional corporation would pay federal taxes on its profits, and you would also pay individual taxes if you receive salary, bonuses, or dividends from the corporation.

  1.  Tax Advantages of the S Corporation

By electing to be taxed as an S corporation, your professional corporation would instead be a pass-through tax entity, like an LLC or a partnership.  Electing to be taxed as an S corporation may also allow you to pass losses from the business to your personal income tax return, where you can use the losses to offset income that you may have from other sources.

Finally, if the corporation pays you a “reasonable salary,” you may not be required to pay self-employment taxes on any shareholder dividends you receive in addition to your reasonable salary.

  1.  Disadvantages To Being Taxed as an S Corporation

A drawback of electing to have your professional corporation taxed as an S corporation rather than a C corporation is the cost of the premiums for shareholder benefits. In a C corporation, costs like insurance coverage are deductible as a business expense. Additionally, the shareholders may not be taxed on the value of the benefits.

Another drawback is the restrictions on who can be a shareholder of an S corporation. For example, S corporations may not have shareholders who are non-resident aliens.

Finally, S corporations may only issue one class of stock whereas C corporations can have different classes of stock that have different rights and liquidation priorities.

  1.  Conclusion

You should consult with your CPA or tax professional to make sure being taxed as an S corporation is the best fit for your professional corporation. However, for most California professional corporations, an S corporation election is likely to provide the most tax savings.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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What Is A California Professional Corporation?

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In California, certain professions are prohibited from forming a limited liability company or a traditional corporation and must instead incorporate as a professional corporation. Professions that are required to be professional corporations include many of those that require a state license, such as dentists, certified public accountants, doctors, veterinarians, lawyers, optometrists, marriage and family therapists,… Read More

In California, certain professions are prohibited from forming a limited liability company or a traditional corporation and must instead incorporate as a professional corporation.

Professions that are required to be professional corporations include many of those that require a state license, such as dentists, certified public accountants, doctors, veterinarians, lawyers, optometrists, marriage and family therapists, psychiatrists, and psychologists.

What Is Different About Professional Corporations?

Professional corporations have more restrictions than traditional corporations.

For example, with a few limited exceptions, officers, directors, and shareholders of a professional corporation must be licensed to conduct the professional activity.

In addition, professional corporations are subject to the regulations of the applicable governmental agency overseeing the profession in which the professional corporation is engaged. For example, some agencies have restrictions on what you can name a professional corporation and require specific language to be included in the professional corporation’s bylaws regarding who can own shares or be officers of the professional corporation.

Who Can Be A Shareholder Of A Professional Corporation?

Professional corporations are also subject to specific rules in the California Business and Professions Code. For example, only licensed persons can be shareholders of a  professional corporation.

Why Form A Professional Corporation?

While professional corporations do not provide liability protection for malpractice, you could have limited liability protection for claims not based on malpractice, such as a slip and fall accidents.

In addition, forming a professional corporation may allow you to deduct payments for benefit plans, such as disability or health plans and group term insurance.

Finally, you should speak with your CPA or other tax professional about whether forming a professional corporation and electing to have it taxed as an S corporation may provide tax savings.

Please contact us at (415) 633-6841 or info@bendlawoffice.com to discuss whether your company is required to be a professional corporation and, if so, the steps necessary to set it up right.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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Top 10 Reasons to Incorporate in Delaware

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Why are so many companies incorporated in Delaware? This article gives the top 10 reasons why more than half a million businesses, including more than half of all U.S. publicly-traded companies and 68% of Fortune 500 companies, have incorporated in Delaware. It then outlines the biggest drawbacks to incorporating in Delaware and explains why it… Read More

Why are so many companies incorporated in Delaware? This article gives the top 10 reasons why more than half a million businesses, including more than half of all U.S. publicly-traded companies and 68% of Fortune 500 companies, have incorporated in Delaware. It then outlines the biggest drawbacks to incorporating in Delaware and explains why it is not a one-size-fits-all solution.

What Are The Benefits of Incorporating in Delaware?

1.  Corporate Law Expertise

Delaware has a highly respected court that focuses on corporate issues – the Court of Chancery.  Because of this specialization, the Court of Chancery has a great deal of expertise and familiarity in resolving complex corporate disputes.

In addition, cases in Delaware tend to be resolved faster than in other states.

No corporation wants to be involved in litigation, but it is reassuring to know potential disputes will be more quickly resolved by a very knowledgeable judge with extensive expertise in corporate law.

2.  Extensive Legal Precedent

Corporate case law in Delaware is much more extensive than in other states due to the high volume of corporate cases.

More case law means increased predictability of the likely judicial resolution of a business law dispute.

If there have been several cases similar to the one facing your corporation, there is less uncertainty about the legal outcome which can be key when strategically deciding whether to settle a dispute or invest the time and capital to litigate.

3.  Delaware Corporate Statutes Are Flexible

The Delaware General Corporation Law (“DGCL”) provides a great deal of flexibility in the organization of a corporation and the rights and duties of board members and shareholders.

For example, Delaware allows one person to be the only director, shareholder, and officer of a Delaware corporation, whereas some other states require at least three people to fill those positions.

The DGCL is also frequently updated to take into account new court and business developments.

Although many Delaware statutes have been mimicked in other states, the extensive case law mentioned above is an enormous asset when determining how a Delaware statute is likely to be interpreted.

4. Attorney Familiarity

Most corporate attorneys are familiar with Delaware business law.  This means your attorney can likely provide more efficient and cost effective assistance if your company is incorporated in Delaware as opposed to a less popular state.

5.  Investors Prefer Delaware Corporations

Angel investors and venture capitalists usually prefer to invest in companies incorporated as a C Corp in Delaware.  If you are serious about receiving investments from these types of investors, you may want to incorporate in Delaware.

 6. Investment Bankers Prefer Delaware Corporations

Many investment bankers insist on a company being incorporated in Delaware before they take it public. If your goal is eventually having an initial public offering (IPO), you may want to incorporate in Delaware rather than converting to a  Delaware corporation later.

7. Sending a Message to Investors

If you incorporate in Delaware, you send a message – “This is a national company.”  From a marketing perspective, this could be important for your customers and investors.  You also send a signal to investors that you understand their preferences and are serious about receiving investments.

8.  Greater Privacy Protections

Delaware does not require officer or director names to be disclosed on formation documents.  This provides a layer of anonymity that is not available in some states.

9.  Quality Customer Service and Quick Turn Around Times

The Delaware Secretary of State’s Office has made it a priority to provide expedited filings. In fact, you can have your filings guaranteed to be processed in less than an hour.

In contrast, California has a 24 hour processing option, but it is not guaranteed to be completed within 24 hours and the rush processing fee is significantly more expensive than in Delaware.  This can be critical if you need to close a deal very quickly.

10.  Less Expensive To Relocate The Corporation

The annual franchise tax in Delaware can vary depending on a variety of factors, but it can be as low as $125 per year with reporting fees.  In contrast, California’s annual franchise tax is $800.

If you incorporate in California and later move the corporation to another state, you still have to pay the $800 annual franchise tax. If you incorporate in Delaware and later move, the annual franchise of your “home state” (where you initially incorporated) could be as low as $125.

What Are The Drawbacks to Incorporating in Delaware?

1. Annual Costs For A Registered Agent for Service of Process

If you incorporate in Delaware, you will be required to have a registered agent for service of process.  The annual fees for this service vary, but companies such as Biz Filings and Legal Zoom charge $129 to $149 each year.

2. Extra Franchise Taxes

If you incorporate in Delaware you will not only have to pay the annual franchise tax in the states in which you are “doing business,” but also in Delaware.

For example, if your company is headquartered in California, but you incorporated in Delaware, each year you will not only have to pay the $800 annual franchise tax in California, but also the annual franchise tax in Delaware.

3.  Extra Reporting Requirements

If you incorporate in Delaware, you will have a second layer of reporting requirements.  For example, if you incorporate your company in Delaware, but are headquartered in California, you would have to comply with the reporting requirements in both states.

If the benefits of incorporating in Delaware described above are not important to your company, you may want to avoid the extra expense and time of being incorporated in Delaware.

If you incorporated your company in Delaware, what have you found are some of the biggest advantages and disadvantages?

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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How Many Shares Should You Authorize For Your Delaware Corporation?

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When forming a corporation in Delaware you will need to indicate on the certificate of incorporation the total amount of stock the corporation is authorized to issue.  How do you decide how many shares you should authorize? There are two schools of thought on this decision: Only Authorize 5,000 Shares. By March 1st of each… Read More

When forming a corporation in Delaware you will need to indicate on the certificate of incorporation the total amount of stock the corporation is authorized to issue.  How do you decide how many shares you should authorize? There are two schools of thought on this decision:

Only Authorize 5,000 Shares.

By March 1st of each year you will have to file an annual report and pay a franchise tax in Delaware.  The tax is calculated based on the authorized shares for the company by using either the Authorized Shares Method or the Assumed Par Value Capital Method.

The Authorized Shares Method is based on the number of authorized shares and is calculated as follows:

  1.   If the company is authorized to issue 5,000 shares or less the annual franchise tax is $175;
  2.   If the company is authorized to issue 5,001 to 10,000 shares the annual franchise tax is $250; and
  3.  For each additional 10,000 authorized shares the annual franchise tax is increased by an additional $85.  The maximum annual tax under the Authorized Shares Method is $200,000.

You may, therefore, decide to authorize the company to only issue 5,000 shares so you pay the minimum amount of Delaware franchise tax each year ($175).

Authorize Millions of Shares.

The second school of thought is to authorize millions of shares, typically 10,000,000 shares.

The rationale is that individuals who receive 1,000,000 shares feel like they are receiving something of greater value. They may be more motivated than individuals who receive 500 shares, even if the shares represent the same percentage of ownership in the company.

In addition, having more shares provides more flexibility in allocating shares on vesting schedules.

The drawback is that in Delaware having more than 5,000 authorized shares results in a higher annual franchise tax.

If you authorize millions of shares, you will most likely calculate the Delaware annual franchise tax using the Assumed Par Value Capital Method.  The calculations under this method can be complicated, but the Delaware Secretary of State’s Office provides a good explanation and examples of how to determine the tax here.

Please contact us at (415) 633-6841 or info@bendlawoffice.com to discuss how many shares you should authorize for your Delaware corporation.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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What Is An 83(b) Election?

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What is an 83(b) election? This article provides an overview of Section 83 of the Internal Revenue Code and how it affects shareholders who purchase stock that is subject to vesting.  “Subject to vesting” means that individuals gain rights to it over time.  This article also discusses who may want to make an 83(b) election… Read More

What is an 83(b) election? This article provides an overview of Section 83 of the Internal Revenue Code and how it affects shareholders who purchase stock that is subject to vesting.  “Subject to vesting” means that individuals gain rights to it over time.  This article also discusses who may want to make an 83(b) election and how to do so.

Who should be concerned about Section 83 of the Internal Revenue Code?

Section 83 should be of concern to founders and employees who receive stock that is subject to vesting.  Two examples:

  1. A founder or an employee sign a restricted stock purchase agreement, or
  2. They agree to a stock option plan that allows them to exercise their options prior to vesting, but subject to a restrictive stock agreement.

These are just two examples; there are many more vesting scenarios. You should consult your tax and legal counsel to determine whether your particular circumstances raise a potential Section 83 issue before signing a stock purchase agreement.

What is Section 83? 

Under Section 83, if you purchase stock subject to vesting, you will pay income tax on the difference between the price you paid and the stock’s fair market value when it vests, even if you do not sell the stock at that time. The holding period for determining whether income from the sale qualifies for long term capital gains treatment does not begin until the shares have vested.

How is the income from stock taxed if you make an 83(b) election?

In contrast, if you make an 83(b) election, the income from the stock is recognized at the time of the stock “transfer” – its purchase date – rather than when the stock vests. The long term capital gains holding period also begins on the purchase date of the stock.

Why is it important when the income from your stock is recognized?

Often the purchase price and the fair market value of stock on its purchase date are the same.  Thus, if you make an 83(b) election, you may not have any income to recognize from the stock purchase and may only have to pay capital gains tax when the stock is sold.

However, if you do not make an 83(b) election, you may have substantial income tax liability when the stock vests if the stock increases in value, even if you do not sell it.

You therefore may want to file an 83(b) election, particularly if you believe the stock is likely to increase in value.  That way the income from the stock will be recognized before it increases in value.  As an added bonus, by filing the 83(b) you will also start the one year holding period for long term capital gains treatment from the date you purchase the shares.

An example of stock subject to vesting under Section 83:

You and a friend start a company and purchase stock at the par value of $.0001 per share, subject to a one year cliff and a four year vesting period.  Your friend promptly files an 83(b) election; you do not.  At the end of the one year cliff the stock is worth $1.00 per share.  Because you did not timely file an 83(b) election, you would recognize $0.99 per share as income, even if you do not sell the stock.  As the remaining stock vests, you would also recognize income equal to the difference between the fair market value of the stock and the $.0001 per share price at which you purchased it.

In contrast, because your friend promptly made an 83(b) election, they would not recognize any income as the stock vests because the 83(b) election accelerated the recognition of the income from the stock transfer to the purchase date.

What are the drawbacks to an 83(b) election?

If you do not pay fair market value for the stock and make an 83(b) election, you could possibly pay income tax on stock that does not provide you with any benefit.

For example: you join a company in June of 2011 that was started in May of 2010.  You purchase 1,000 shares of restricted stock at the par value of $.0001 per share.

However, the company has been running for over a year and the fair market value of the shares is no longer par value, but is instead $1.00 per share.

If you file an 83(b) election, you would pay income tax on the difference between the fair market value of the stock and what you paid for your shares.  In this example, you would pay income tax on $990.90.

If the company dissolves and the stock is worthless, you would not receive any benefit from the income tax you paid.  In addition, if you later forfeit the stock, perhaps by leaving the company, you will not be allowed a deduction for the income tax you paid on the stock at the time you made the 83(b) election.

However, if the purchase price and the fair market value of stock are the same and you make an 83(b) election, you would not have any income to recognize from the stock purchase and may only have to pay capital gains tax when the stock is sold.

How much time do you have to make an 83(b) election?

You must file an 83(b) election no later than 30 days after the stock has been transferred.   The stock has been transferred on the purchase date of the stock, which is when you assume ownership of the stock.  The postmark date is the date of the filing.

How do you make an 83(b) filing?

The 83(b) election must include:

  1. Your name, address, and tax identification number.
  2. A description of the property for which you are making the election.  For example, “25 shares of common stock in X company.”
  3. The date on which the property was transferred and the tax year for which you are making the election.
  4. The nature of any restrictions on the stock.  For example, “Stock must be forfeited if employment terminates before June 1, 2015.”
  5. The fair market value at the time of the transfer for which you are making the election.
  6. Any amount you paid for the stock.
  7. A statement that you have provided the required copies of the election, such as: “I have provided copies of this election as required in the regulation.”

The IRS does not provide a form 83(b) election, but you can find a sample 83(b) election form here.

Where do I file the 83(b) election?

The 83(b) election is filed with the IRS office where you file your tax returns.

We recommend that you also include (1) an extra copy of the form, (2) a self-addressed stamped envelope and (3) a transmittal letter that requests that the IRS acknowledges receipt and the filing of the 83(b) election form by date stamping the extra copy of the form and returning it to you in the self-addressed, postage-paid envelope.

It is strongly recommended that if you decide to make an 83(b) election, you send it via certified mail with return receipt and that you keep that receipt in case you ever need to document that you submitted the form.

Do you have any 83(b) tips or advice?  If so, please provide them in the comments below.

Disclaimer: This article is intended to provide information for your general education.  It is not intended to be used and should not be used for the purpose of avoiding federal income tax penalties.  Although the article discusses general legal and tax issues, it does not constitute legal advice.  You should not act or refrain from acting on the basis of any information in this article.  Instead you should seek the advice of tax or legal counsel who can discuss the facts and circumstances of your particular business or personal needs.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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The Top Six Reasons Your Company Should Have Strategic Bylaws

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Why should your company have strategic bylaws? California does not require a company to have written bylaws. However, every business should have a set of strategic, written bylaws to optimize company operations and legal protections. Here are 6 reasons why: 1.  They are the Company’s Legal Backbone A company’s bylaws provide the legal framework for… Read More

Why should your company have strategic bylaws? California does not require a company to have written bylaws. However, every business should have a set of strategic, written bylaws to optimize company operations and legal protections. Here are 6 reasons why:

1.  They are the Company’s Legal Backbone

A company’s bylaws provide the legal framework for how it operates. This includes the number of people who serve on the board of directors, how to call a board meeting, and the officer positions for the company.

2.  What if Your Company Does Not Have Bylaws?

If your company does not have bylaws in place, the laws of California will control how the company is run.  It is much better for the owners to determine how the company should operate than to rely on the state’s default.

This is similar to an individual not having a will or trust.  If they die, the state’s statutes determine how the individual’s assets are distributed. Instead, each individual should thoughtfully think through how they would like their assets distributed and to set up the legal mechanism to enforce their plan.

Similarly, it is much better for business owners to think strategically about how they would like their company to operate. Relying on state statutes might not always be the best fit for the company. The bylaws then serve as the legal framework that supports the business strategy.

3.  They Provide Owners With Piece of Mind

Every company runs into challenges eventually.  It is better to consider some of the potential turning points in your company and provide for them in your bylaws. This preemptive approach allows you to determine how you would like the outcomes of these situations to be determined, rather than waiting to make tough decisions when interested parties and passions may create the perfect storm for litigation.

For example, what will happen if there is a legal dispute between the owners?  Do you want the company to be tied up in the expense and distraction of litigation or would you prefer arbitration?  What happens if one of the owners dies?  What if one of the owners wants out of the company?

The bylaws present an opportunity to calmly and objectively reflect on these issues before they occur.  It is wiser to answer these types of questions ahead of time and determine what might be the best solutions for your company than to rely on the default rules in the state’s statutes or to try to resolve them when clear heads are less likely to prevail.

 4.  Bylaws Help Protect Your Company’s Limited Liability

One of the primary reasons to form a corporate entity is to possibly have personal limited liability from the potential business debts and judgments against your company.

If a company does not have bylaws and is sued, a plaintiff could try to “pierce the corporate veil” by claiming the company should not be provided with the shield of limited liability protection because its owners did not follow corporate formalities.

In determining whether to pierce the corporate veil, the court would evaluate a number of factors to determine whether your company is legitimate, including whether you have the proper corporate documents and records.  By not having bylaws, a business owner is risking not being provided limited liability protection if sued.

5.  They Prevent Misunderstandings Among Owners

Communication and clear expectations are key to any successful relationship including the relationship between business owners.  Bylaws clearly lay out how the company will be run which can be crucial in preventing misunderstandings over how the owners expect the company to be managed.

6.  You May Need Bylaws To Get a Bank Account, Loans, and Insurance

Finally, if you would like to open a business account or apply for loans most banks will require you to provide a copy of your bylaws.  In addition, insurance companies may require you to provide a copy of your company’s bylaws before providing certain types of polices.

As a business owner, it is often tempting to cut corners to lower costs. A strategic, thought out set of bylaws should not be one of these corners.  Instead, bylaws should be recognized for what they are – one of the wisest investments a business owner can make to ensure the long-term effectiveness of their company.

If you have any questions regarding bylaws or any other business legal issue, please contact us at (415) 633-6841 or info@bendlawoffice.com.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.

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