HOW TO INCORPORATE

How to Create a Pre-Incorporation Agreement

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This article describes a pre-incorporation form designed for people who plan to incorporate a small business owned by a handful of shareholders, each of whom will actively take part in the day-to-day operations of the business. Although not legally required, a pre-incorporation agreement can be a very useful aid to starting a new corporation. The process of drawing up an agreement can be of crucial help to allow you and other owners to focus on key business issues. Sometimes doing this may even cause you to abandon the idea of starting the business. If so, this should be seen as a positive development. It's much better to confront tough management issues early rather than after everyone has invested money, time and energy in a business enterprise.

Instructions for Pre-Incorporation Agreement

1. Shareholders' Names

Insert the names of all shareholders.

2. Incorporation

Insert the state in which you plan to incorporate. Corporations are created under state law rather than federal law. Each state has its own rules for how to start a corporation. The best place to form your corporation is the state in which you and the other incorporators live and that will be your primary place to do business. Disregard suggestions that there are advantages for a small business to incorporate in Delaware or some other state. By and large, this is malarkey, since in most cases you'll also have to pay fees to the state where your business is located.

Usually, a state office--such as the secretary of state--can provide a form for the articles of incorporation. Plan to attach a copy of the articles of incorporation to the pre-incorporation agreement as an attachment (and label it, for example, as Attachment 1).

Legal jargon for basic incorporation documents differs from state to state. In some states, the articles of incorporation may be called something else: certificate of incorporation, charter of incorporation or articles of association are common variants. But no matter what your state calls the forms necessary to register your incorporated business, one thing is true everywhere: you'll have to file it along with a fee at your state's incorporation office. You won't, however, need to file your pre-incorporation agreement.

In some states, the signature of just one person is required on the articles of incorporation. If that's permitted in your state and you want to have one of you sign that form, check the first box and fill in the name of the designated signer. If the law requires or if you want other shareholders to sign, check the second box.

3. Corporate Name

Fill in the name of the new corporation. Be sure the name complies with corporation laws of your state. For example, you may be required to include one of the following words or abbreviations in the name of the corporation: Corporation, Incorporated, Company, Limited, Corp., Inc., Co. or Ltd.

Check in advance on name availability. Every state prevents two or more corporations from registering or using the same name, or even names that are very similar. Accordingly, you should check in advance to see if the name you want to use is available. Contact the state office that handles corporate filings. Usually they'll be able to tell you by phone if there's a potential conflict and, if there isn't, explain how you can reserve your proposed name for a month or two to give you a chance to file your formal incorporation papers. Unfortunately, finding that a name is available in your state doesn't guarantee that you can use it. Especially if you will use the name to identify goods and services, you also need to see if your name violates another business's trademark.

Check the second box if you're planning to use a secondary business name that's different from the official corporate name. Then fill in the name.

Examples:

  • Apollo Furniture Inc. wants to do business as Apollo--a shortened form of its official name. It inserts the name Apollo in the space.
  • Apollo Furniture wants to do business as Contemporary Studio--a name completely different from its official name. It inserts the name Contemporary Studio in the space.

You'll need to make your secondary name a matter of public record. State law will probably require you to file an assumed name certificate with a state or county office. And in some states, you'll need to publish a notice in the newspaper supposedly informing the public of your fictitious name. This will let the public know that the business called Contemporary Studio, for example, is just another name for Apollo Furniture Inc.

4. Corporate Purpose

Insert the purpose of the corporation. Use simple language and describe the purpose broadly enough to cover all your intended and possible activities.

Samples:

  • to operate one or more retail stores for the sale of computer software.
  • to manufacture and distribute equipment for the preparation of espresso, cappuccino and other coffee-based beverages.
  • to design Web sites for computer users.
  • to cater banquets, picnics and other functions requiring food service, and to rent equipment to be used in connection with these catering services.

5. Corporate Stock

Insert the total number of shares the corporation will be issuing to the shareholders signing the agreement.

There's a difference between authorized stock and issued stock. Your new corporation will be authorized under state law to issue a certain number of shares of stock. The number is usually established at the time you incorporate and in some states will be tied to the fees you pay the state for incorporating (the more you issue, the more you pay). Just the same, it's a good idea to have plenty of stock authorized so that you'll have some in reserve after you issue shares to the initial shareholders--although if you run out, you can always get authority later for more stock.

This paragraph of the shareholders' agreement deals only with the shares you'll be issuing to the initial shareholders and not with the total number of shares authorized.

This paragraph also assumes that all your shares will be common stock, meaning that there's no guarantee that dividends will be paid. No problem. As a practical matter, because income tax laws tax money paid out in dividends twice (once at the corporate level and once when paid to the shareholders), most small businesses instead compensate their owners through salaries, bonuses and fringe benefits which are taxable to the shareholders, but tax deductible business expenses to the corporation. And even if it might be a good idea to issue preferred stock (under which owners receive a fixed dividend before dividends are paid to common stock owners), doing so is simply too complex for most small businesses.

Last updated: Oct 21, 1999




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