Closely held corporations are a common business structure. These corporations have few shareholders and directors, often family or friends. There are advantages to incorporating a company, such as tax savings and limited personal liability. But risks usually accompany advantages and so it is with operating a corporation. Good corporate practices started early can minimize those risks.
Lack of communication causes most problems. Especially in small closely held corporations, people tend to avoid essential steps in good corporate governance and operation. The reason for avoidance might be a lack of time and energy; people prefer doing work that generates income rather than committing to internal affairs. Costs can be another factor, especially if it means retaining outside professionals. Ironically, trust can be problematic too. Matters are not put down in writing because the directors/shareholders have been friends for years and trust each other. Problems can be avoided if best practices are put in place at the beginning and become part of a company’s normal affairs. If this is done from the start it becomes an expectation.
Small corporations often fail to prepare directors and shareholders resolutions and when necessary, hold directors and shareholders meetings. The directors are the directing minds of the corporation, with the shareholders exercising final control. For important decisions such as the sale of an asset, a directors resolution should be prepared and signed by all directors. This proves the consent of all directors to the decision. If there is dissent, a meeting should be held to discuss the issue and vote on the matter. The resolution that results from this will prove the consent of the majority of directors. Similar steps should be taken with vital corporate matters requiring shareholder consent, such as a sale of substantially all of the corporation’s property. These issues should be discussed, voted on by shareholders if necessary and reduced to writing in a resolution.
By not securing agreement and documenting these matters there can be problems later. Things can be especially tricky if, for example, one director enters into an important transaction on behalf of the company without informing anyone. The company may be prejudiced because the third party can still hold the company to the deal, despite any objections of the other directors. If the innocent third party assumed that the one director was authorized to enter into the transaction on behalf of the company, the rest may be stuck with the deal. Matters can get worse if a director carries on like this over a series of transactions before the other directors finally object. Their inaction may create a presumption they agreed to the company conducting its business in this manner.
Small companies also often fail to prepare unanimous shareholders agreements. These contracts can cover many areas of shareholder relations but important elements are the circumstances where shareholders can sell or be bought out, the mechanics of the transaction and valuing the shares. Without a standing agreement, these issues have to be worked out at the time they arise (i.e. when someone is leaving the corporation). This can lead to protracted negotiations between the shareholders, possible disagreement, and even litigation. While a USA cannot always eliminate litigation, it can minimize the risk. In the majority of cases, the shareholders will follow the process they agreed to at the outset.
In small companies, directors and shareholders are often the workers too. When a company is created it is best to decide if this work is going to be paid by the company. The law usually does not impose an obligation on the business to pay a shareholder a wage for work performed. Even if a wage is implied, the amount to be paid may not equal the market rate for an independent employee. The shareholder’s compensation is often seen to come from share value and dividends. Any wages awarded could be minimal, if at all.
The shareholders’ expectations, whether to pay wages or not, should be agreed from the start. If wages are expected, document this with an employment agreement describing the duties to be performed and the compensation. Leaving this issue unsaid can lead to legal problems down the road, especially if a larger dispute arises between shareholders. A shareholder may harbor a grudge, perhaps legitimately, for unrewarded labour and make a claim for wages.
Unanimous shareholders agreements, employment contracts and resolutions or meetings may seem like nuisances or unnecessary expenditures when starting a new business venture with friends or family. However, investing in these matters can avoid or minimize problems in the future, especially if the personal relationships within the corporation break down.