Corporate Form and Record Keeping with Mike Abel
Deciding the way you structure your start-up is one of the first things you must do, but there are many places where things can go wrong. One of the biggest pitfalls of young start-ups is a lack of records.
Mike Abel: Oh, thank you, Arin. I appreciate it. Yeah, you’re right. A lot of people from the beginning, they start off on the wrong foot. They don’t have proper formation. And then throughout the life of the corporation, they don’t keep track of anything. We’re dealing with one right now. I have a startup that wants to sell and go ahead and do stuff, and we’re looking back through their corporate books. And it’s going to take weeks about a month or two to get it straightened out because they did so many things wrong. So it is a timely topic. It’s a good topic, especially for any startups out there to make sure they do things right at first. Otherwise, you know, right now this is holding up the sale, so and it’s going to take that long. So you don’t want to do that.Arin Vahanian: Sure. So, yeah, I mean, I’d love to discuss some of these real life examples. Mike, maybe you could tell us a little bit about yourself & Abel Law real quick, perhaps.
Mike Abel: Yeah, I have a law office here in Arizona. I’m licensed in Ohio, South Carolina and Arizona. Been doing this for nearly 30 years. In addition to my law license, I have an LLM in international taxation. So I do a lot of cross-border structuring of counsel for Esquire Group that we do cross-border transactions and advice on taxation & corporate formalities. So I do this every day. This is basically my bailiwick of good corporate governance, sales, stuff like that.
Arin Vahanian: Wow, thank you. That’s that’s really great, and I think it’s going to. Your expertise is going to be so, so important to our listeners. So going to today’s topic: Record keeping in terms of a startup or corporation. What are some of the most important things for startup founders to get right from the beginning?
Mike Abel: Yeah, from from the very beginning. You know what I stress and I find so many problems are, is, you know, people will go out and DIY or they’ll get online and try to find the latest and cheapest online solution. But those companies – even when they’re doing it themselves, they don’t get the initial paperwork right. That is my biggest problem that I see because it’s not just filing articles of a corporation for a corporation or articles of organization for an LLC; that doesn’t form anything that’s just sending it on the public record that, “look, this is what I’m trying to do.” And you don’t know how many times I have clients that walk in and say, “Oh, I’m a corporation/I’m an LLC” and they give you the paperwork and I go, “OK, where is everything else?” You know, when you file your corporation, you know, one of the mistakes that typically is in 80 percent of them is you have to go ahead and file the articles by the incorporator. The incorporator needs to resign because they’re the only officer, everything from the beginning. If they don’t resign, which people don’t, they just keep moving on. You can’t do that. You have to have that resignation in there.
Mike Abel: You know, startups, typically, if there’s going to be more than one person, I’m really more touchy with it. “Ok, where’s your subscription for these shares?” “What do you mean? I just said, I have one hundred shares.” “You don’t have documentation that you even wanted these shares.” We need to have a share subscription. Did you adopt your bylaws? You’d be surprised how many corporations I look at their books, they don’t have any bylaws. You know, you’re not a corporation when you do that, because how are you governing? You know, your bylaws are going to set out everything for your corporation – how you’re going to govern the corporation. “We don’t have that” and then they’ll go down from there and you’ll look and say, “OK, where’s your initial directors meeting minutes and your shareholders?” Because people get it backwards on how a corporation actually works and they don’t realize they say, “Oh, here’s the directors.” Well, how’d they get there? They’re elected. Directors are elected by shareholders. Shareholders do not run the company. The only thing they do is elect the directors.
Mike Abel: So you say, “where’s your initial shareholder meeting minutes?” “Well, we don’t have them.” Again, you’re not a corporation. And then you go from there and say, “OK, How do you get your title of president?” They’ll say, “Well, I own the company. I should be president.” Well, that’s not enough. You have to have that in writing in your initial directors meeting, and you’d be surprised they don’t have that. So, you know, these are all little things that need to be done for a corporation to be valid from the beginning.
Mike Abel: And one thing that they also shares. This is where you have to look at states that you’re incorporating. Some states still have the old regulation stuff, and they require shares and stuff like that as far as as a hard copy: here’s a certificate. But most states don’t. And I always tell my clients, OK, you’ve got to issue your shares. This is part of the initial formation process – part of the paperwork must be in there. Well, I hate to have physical shares because what happens is they get lost and if they get lost now, we have to do a lot of work to go ahead and find them. Basically, we have to do resolutions to go ahead and get rid of that share to issue a new share, a duplicate share all this stuff, you know, and some attorneys love it because we charge about five hundred dollars per share to do that because we have these resolutions to where if they’re smart, in their bylaws, they’ll adopt what’s called certificate-less share system. And what it does is it creates a share registry. And then that way everything’s on the share registry. And when we come down to sell a company or we are getting a new investor, we’re not out there looking for shares of stock to say, “OK, we’re going to transfer this. We got to transfer that. We don’t have it.” So all these are initial things that if they don’t do right, can put their company at risk down the road because it won’t even exist.
Arin Vahanian: Yeah, well, that’s a ton of useful stuff right there. And I have to admit even some of that was new to me. I think I think you highlighted one thing that I’ve seen as well among startup founders that is, oh, I’ll just do it quickly and on the cheap, but something that’s not created right from the foundation that’s going to produce a lot of problems later, right?
Mike Abel: Oh, yeah, yeah. That leads to attorneys like me easily piercing the corporate veil, getting personal liability. I have a client right now that we’re getting ready, trying to sell it, and we got at least another month’s worth of work because their books are so out of whack. They don’t have the resolutions, they don’t have everything. We have to re document them. We have to go back and find things. They’re searching all their their history to see what time they made major purchases. All this stuff because we have nothing documented and the other side won’t even consider touching the company because they’re afraid that somebody is going to sue them. And if they do, the members are in this case, it’s the shareholders rather, would be liable for everything. but it’s almost like you’re going to go online. “Hey, Johnny needs to go ahead and have a filling – I can watch this video online. I’m certain I can do it.”
Arin Vahanian: That’s a great analogy.
Mike Abel: Yeah, if that’s what I tell people, that’s why we hire people to do things. You know, I always joke that, yeah, I’m great at research, great at doing that stuff, and I could probably find out how to fix my car. But dang it, I’m not going to do it. You know, it’s just out of my profession. It’s like with startups, you might spend a little bit of money to do it, and you might say it’s expensive to start these things properly. You know, it’s expensive is not starting it properly and then down the road wishing you had because it costs three, five, 10 times more for me to fix it than it would for me to have created it. So those are things you really understand when they’re going to.
Arin Vahanian: That’s a great point, Mike.
Mike Abel: Yeah, it’s the same thing with if they really have something they think is going to make out, they need to get a good tax adviser up front. Because if they don’t have tax advice up front on how to structure for the long term, they’re going to have a lot of issues, too. So I just sat down with a tax professional and he blew my mind because we’re finding out there’s all these deductions and stuff that you know, I didn’t even know about was, you know, it’s a Home Office type thing that you can get for 12 meetings a year and stuff. And I’m “I didn’t even know about this. How did I not know?” I felt terrible. You know, I’m supposed to know some of the tax world, so I get good advice. You have to find somebody that’s good.
Arin Vahanian: Yeah, for sure, and Mike, one thing you mentioned that I’d like to focus on real quick is you mentioned piercing the corporate veil. Can you maybe tell our listeners about what’s what’s sort of the risk there with setting up things incorrectly from the beginning and then in terms of a potential liability?
Mike Abel: Yeah. Everybody knows when you have a corporation, the reason why you’re going to incorporate and I’ll talk about LLC a little bit later on, too. But when you incorporate or you form your LLC, what you’re doing is trying to insulate yourself from personal liability. And that’s what we hope the corporate veil does. However, if something goes wrong and I’m suing the corporation and I want to go ahead and say, Aha, I want to make a lot of money out of this because it was damaged. But the corporation doesn’t have much money or it doesn’t have enough value, isn’t liquid enough. I want to get paid. So the first thing we attorneys do is we ask for a copy of all the corporate books, all the corporate formalities that have occurred since the beginning. And then we start digging and we find stuff such as, you know, their reservations are not there They never had enough directors. You know, they didn’t follow their corporate guidance. They didn’t have resolutions, yearly meeting minutes. And we’ll go over all the stuff in their corporate book.
Mike Abel: Then it’s pretty easy for me to show that the corporation was not following the formalities necessary to maintain that corporate veil. Therefore, it’s an alter ego is one of the things we pierced with alter ego of the owners, and now they’re personally liable for everything. Just because they chose to do it quick, not get good advice and read something on Wikipedia that they thought was accurate. So that stuff that they really need to be concerned about because they don’t want to be personally liable. And that’s what happens so many times. And that’s what I do. A lot of times, I’ll have people that come to me and say, Hey, look, I want to might be getting sued. And I have to have a long talk with them about all the stuff that’s wrong in their corporate structure and what they might have to do to either fix it in a hurry. Now, hopefully, that doesn’t hold up or get ready to be personally liable because you’re going to get through that pretty easily. So that’s what happens if they do it that way.
Arin Vahanian: Sure. You know, if that happens, that pretty much defeats the purpose of having an LLC.
Mike Abel: Oh yeah! They might as well not informed it because you know what we’re trying to do is, you know, “I don’t want somebody coming after me. I don’t want somebody taking what I have personally away from me.” Well, the statutes are very clear. And that’s where people mess up. The statutes are very clear. It says you get this personal protection if you do a, b, c, d, e, and it says everything they need to do and if they’re not doing all those steps, that was the if you have this protection – If. So, that’s why it’s so important we try to set up. We tell our people that we set up corporations for. One of the things we offer right up front is we tell them this is the risk we are going to offer you a yearly service. This is what it’s going to cost. We will guarantee that you’re meeting minutes are there. We will guarantee that if there’s an update to be filed on the Secretary of State’s Office, the corporation commission or whatever it is in that state, we will make sure that the corporate formalities are met. A lot of them take it, a lot of them don’t. And of course, when they don’t take it, we send them a letter saying that we advised you beware because it is so important.
Arin Vahanian: That’s right, and Mike I have to say, it looks like the level of detail that you look at, your firm looks at, it’s just really huge. It’s just so important, especially for startup founder and a lot of founders don’t necessarily have a legal background. They don’t have the sort of background that would enable them to know all this stuff up front. Right. And so I guess based on that, Mike, let’s just say there’s a startup, and for some reason they decide to not go with Abel Law. What would you what sort of advice would you give our listeners today in terms of how do you select a good attorney when you’re starting a company?
Mike Abel: No, there’s several different ways. It’s sort of like, I guess, they trade off on and off a lot of times people have a tax professional they’re working with. Ask them! Because I get a lot of referrals from tax professionals that I do business with and they get referrals from me because I know who’s good and who’s not on a tax side because of my experience with them. They can ask some friends, do some basic research on firms that do corporate formalities, see what they’ve done. You can go online and search their name and see how many people they represent as a statutory agent. You know, interview them. Have you done any work with startups? What type of corporations have you set up? And is a corporation right for me? Because there’s a lot of times it’s not to where we want to do a different structure, an LLC, you know, it depends what it is. I do a lot of asset protection too for people, that if we even do initial start up company, we’ll go ahead and do asset protection at the same time. Well, I don’t want to use corporations. I want to use LLC. In most states, it’s much better to use an LLC; it’s harder to collect against. All this other things. So they really need to make sure they have somebody that is very knowledgeable in this area. So that’s just questions they want to make sure. What have they done? Give me some experience history. And go from there.
Arin Vahanian: Wow, good points there, thanks for that, Mike. And then you mentioned LLC and C Corp. I think I think a lot of times when you talk to new business owners now, whether it’s a tech startup or whether it’s not, I think a lot of people are under the impression of, “Oh, I’ve got an Incorporated C Corp. There’s there’s no other form of organization that will work for me.” And that’s pretty wrong, isn’t it?
Mike Abel: Oh, it’s tremendously wrong when you’re looking at a corporation or something at the beginning, what we usually do is we’re saying, OK, what’s your long term plans? And if they’re not thinking about going public and stuff like that and they’re saying, Well, it’s just going to be me and my friend, we’re going to do this. We’re going to set the world on fire. And OK, great. You know, chances are you’re probably going to want to do an LLC. And the reason why you’re going to want to do an LLC is flexibility. See, when I file a corporation and people also get this wrong with corporations, you ask them to say, “What do you got?” “We got C Corp, I got an S Corp.” I go, “No, you’ve got a corporation.” And they get mad. “No, I got S Corp.” “No, you have a corporation that is chosen to be taxed under the code for an S election. Same thing for a C.” So, you know, I don’t do as many C corporations unless it’s somebody that they’re going to probably be going public or we’re doing exchange out to where we’re doing a merger to go public, to where we’ll take them to a corporation.
Mike Abel: So they really need to look at what they want to do and then they need to talk to their tax professional. And, you know, I help them with this a lot too is: OK, what type of income going to be generated? Is it going to be an active income? Is it going to be a passive income? Because it’s going to be an active income, then we have to look at either, you know, not being a disregarded or partnership or whatever it would be for an LLC, but it would be maybe an S Corp election so we can save money on self-employment tax if it’s active income or else we’ll go with a C corporation on rare occasions if we need something bigger. But these are all things that really get overlooked all the time by companies and especially startups. They don’t realize that, you know, nobody ever planned to fail. They just failed to plan. So that’s the old axiom that people said, and that’s what happens with all this stuff.
Arin Vahanian: Wow. Really good points there, thanks for shining some light on that, because I think that’s an area that startup founders struggle with. From your experience, Mike, so you mentioned earlier today that – Yes, it does cost money to do it right from the start, but it’ll cost more later to fix it. What are maybe some real life examples that you can share with us, maybe from (obviously you don’t have the name of the client) but just from your work that that you’ve seen where things were done wrong and then you had to fix it.
Mike Abel: Yeah. Well, you know, the company I’m working with right now. You know, they have major investor who can buy them out and stuff. Well, they won’t touch the company. Going through the corporate books we found out, one thing missing – one thing you must do every year for your corporation. And I’ve been starting to advise my LLCs to consider it now is you have to go ahead and do a yearly meeting minute of the directors and the shareholders. They have to go ahead and resolve, you know, how often your directors are elected – depends on your bylaws, you don’t have your bylaws. I got to fix that. They lost all their stock certificates, everything in this company. That’s how bad it is. And then, you know, you got two or three yearly meeting minutes that they didn’t have; they didn’t reappoint their directors for 10 years. So even though they thought they were a director, they weren’t directors because they had no meeting minutes to appoint them. We had to go back and recreate all of this stuff. And then we had to master resolutions to consent to the actions that were taken in the past. I mean, there’s a lot of documentation and it ends up that, you know, one cost was attorney fees, probably about twenty five thousand, at least to get it in order that if he had a paid us along the way, it had been about five. It’s delaying this sale and this sale could fall apart wholeheartedly if they don’t like what it is, and this is going to cost them millions. So I think that that’s not a good thing that they chose to do along the way. So that’s one of the examples.
Mike Abel: You know, corporation to maintain their formalities every year, like I said, they have to have the yearly meeting. They want to include such things as: did you sign any new big contracts, not 5000? No, I signed something with 300,000. Did I purchase a building? If you purchased the building, then you want to make sure that you do a resolution at that time. But if you didn’t, we put them in the yearly meetings to go ahead and say, we confirm that. All these things need to be documented on a yearly basis, and other times.
Mike Abel: I know one that’s the most common that I see in problems is when we open up a business. First thing we do is we go to the bank, we open up our nice bank account. When you get there, you’re saying, here is my articles. Here’s everything we have. They say, great. Oh, the bank requires a resolution for you to open a bank account. You say, OK, I don’t know what it is. You sign it and give it to the bank. Ok, now I ask for your corporate records, I’m going to sue you, I’m going to say you have a bank account. Yeah, show me your resolution authorizing you to open a bank account. You didn’t get a copy for your corporate book. If you’re signing something like that, it needs to be in your book, you’re getting a loan under your business, get a copy of the resolution that you – probably if it’s against real estate – the title company had you signed. Get a copy of that. Put it in your corporate book. Make sure you have all these things. You want to make sure you’re doing that with anything that you do.
Arin Vahanian: Great point, Mike, and I would like to add to that, we often advise our clients of the same thing, specifically the importance of good recordkeeping. You mentioned having it in your book, right?
Mike Abel: Oh yeah. If it’s you know, the problem is and also I tell them backups, backups, backups, backups. There’s no reason that you don’t have everything saved to the cloud right now. It just you have to have something. If your computer blows, I still have it. My building burns down, I have it. Have all of these things saved because we can live with duplicates. If the originals go away, don’t care. Your shares of stock, you know, most people like to see those nice little chairs. I wouldn’t have them. I would make sure that my my bylaws called for a certificate list share set up, which is nothing more than you keep an Excel spreadsheet basically on a stock registry. And here’s all the shares and here’s how they went. And you keep track of it that way because if you lose those things. Great. We have to do a bunch of resolutions and issue a new share and type it up and charge you five hundred bucks. Why would you want to do that? So these are all things that they don’t know. People starting up companies, they don’t know. Another one I got with how they look online to do stuff, my daughter in law got me a mug that we have in the office that says, Excuse me, but your Google search doesn’t suffice for my JD or my law degree.
Arin Vahanian: Or my medical degree! That’s right.
Mike Abel: Yeah, yeah. It’s like, OK, don’t let that you think that it’s superior, OK? It’s not. There’s a lot of things..
Arin Vahanian: Right.
Mike Abel: That we learn that are not out there. We learned from actually being in the trenches and seeing people get sued. I’ll give you a prime example. My one, I use all the time about owning rental units. And I always tell everybody, “how do you own your rental units?” “Oh it’s on my personal name” and I said, there’s a medical term for that. It’s called batshit crazy. You don’t do it. And here’s why. I look at insurance companies. Insurance companies’ number one job is not to pay. They make money. They don’t want to do. I had a client back when I lived in Ohio and I was practicing there, you know, about 60 70 rentals. And luckily, he had me as his attorney. And when you own rental units, every rental unit needs to be in a separate LLC. You don’t want 10 or 20 of them into one, you want one and every separate LLC. That’s a lot of money. Yeah, but imagine this. It was wintertime, and he had an up down duplex and he walked up the steps along the side and there’s a landing railing. You go in the upstairs. Well, it’s Christmas time they’re having a party. And he had no smoking in his house. We’re not in the house smoking, so he had friends that were outside smoking. One of them was leaning back against the railing and it broke. He became a paraplegic. He sued my client. The insurance company denied coverage because they went to the house and they asked the tenant what happened? He said, “We have this party and everything. Guy leaned against the railing. Then he went “wow did the landlord know about that?” He said. “I’ve been telling the landlord they had to fix that railing for like six months.” Inside your insurance policies, if you know of a known danger and you do not remedy it, you no longer have coverage for that danger. They went ahead and denied coverage. He lost that unit, but luckily because we had good corporate documents or LLC documents, operating agreement, EIN, and we had everything documented. They put a lead on it, sold the property. He lost one, not 60-something. That’s where good corporate formation, good LLC formation, keeping records will save you. You’ll lose one, maybe – I can lose one of 60 houses. That’s fine. He was happy to it and we didn’t even require him to sell it. We just went ahead and said, Here we’ll sign the deed over to your choice, you know, but it saved him millions. So that’s another real life.
Arin Vahanian: That’s incredible look, that’s a really unfortunate situation.
Mike Abel: Oh yeah.
Arin Vahanian: But it’s actually a perfect example of what you were talking about. Right?
Mike Abel: Yeah.
Arin Vahanian: Just getting these small details right in the beginning…
Mike Abel: Yep.
Arin Vahanian: Leads to potentially not getting into a situation in which you’re at risk for millions and millions. You’re losing your livelihood.
Mike Abel: Yeah. Everything you’ve ever owned. And I felt sorry for the guy, everything. But I also look at my job or anybody’s job as we want the insurance. We had insurance he thought it would cover. Everything else still disputes on. If know he told him or not. I believe my client that he was never told, but these are things that we do to protect ourselves. I don’t want to work 30 years of my life to have one tragic accident wipe my life out because, you know, we don’t resolve, you know, hardship by punishing two people and two people lose type thing. So they really want to watch when they do this from any startup company.
Arin Vahanian: Yeah, you’re so right, Mike. Thanks for that. Again, that’s a fantastic example of why this topic of record keeping and books is so, so crucial. Mike, so going back, you made a comment about the cloud. And just for our listeners, it’s, and by the way I get this question, believe it or not, they ask, “Is it OK to have everything digitally saved? All documents saved digitally? I don’t actually need physical copies. Let’s just say they burned down or I lose them, right?”
Mike Abel: Yeah, I’m still old school. I love my paper. However, I have everything saved in the cloud. I mean, literally, we got rid of a lot of our client files. I’m a pack rat. I had them, I think out of my entire career I might have lost 20 files. And just over the past three years, my wife told me and convinced me to go more to the cloud and embraced it. And staff’s been scanning everything in the cloud. It’s OK. I can live with those copies because we can say, “Hey, sign an affidavit. The corporate books have been destroyed. Here’s the replacements we have. Copies that have always kept in the cloud. Perfect.” That suffices. I’m happy with that. We don’t need the actual wet signature. It’s good if somebody can test it to have it. But I still tell my clients I like to keep the hard copies. Please keep them. But if you don’t, at least make sure I have them that I can get them in the cloud, that everything’s there, all our documents.
Mike Abel: Even LLC have formalities, you know, they tell you that, you just file your articles organization – the operating agreements. Most statutes provide that this is what happens if you don’t have them. Well, we don’t want them. They are terrible. We just passed them out here in Arizona that are horrific. So you always have to have an operating agreement and then always get an EIN. But my tax professional says I don’t need an EIN because I’m a sole member, and so it’s disregarded. Don’t care. It’s a reason why we attorneys ask that question is because then we’ll say, Oh, it’s just an alter ego. Then you’ve been using your own name. You’ve been doing all this. You got to have somebody that advise you that. Start, you know, making sure everything’s kept separate, don’t co-mingle funds, for God’s sakes. Don’t pay your personal house payment out of your business account. You know these are things that just crush it
Arin Vahanian: Goes back to corporate piercing the corporate veil, right?
Mike Abel: I had a client that was doing that too, and I actually fired a client. I fire a lot of clients if they don’t listen. And this guy literally was paying absolutely everything of his living expenses out of his company account, his house payments, car payments, electric bills, everything. And then from your side with tax and he was deducting all of it. And he told me how wrong I was that he could do this, and I said, You’re fired. Send him a letter saying, I advise you not to do this. I will not represent you anymore.
Arin Vahanian: That’s right.
Mike Abel: So those are bad things.
Arin Vahanian: Well, Mike. I just have to say how much I enjoyed our session today. There’s just a ton of useful stuff here. Once again, I’d like to thank you for joining us today here at PoloTax Start-Up Nation. And again, I can’t stress enough how important today’s topic is. Thank you so Mike.
Mike Abel: Thank you for having me. I enjoyed it. Have a good day.
Arin Vahanian: All right, you too. Take care.