How to Properly Distribute Shares in a Corporation
If you don’t have the time to read the entire article, at least remember this: the number of issued shares may not exceed the number of authorized shares.
We delve into the respective responsibilities and distinctions between incorporators, directors, shareholders, and officers.
If you are planning to form a C-corporation (C-corp) in the US, you need to be aware of its “main actors” in order to appropriately allocate responsibilities, draft the necessary initial corporate documents, and follow the required corporate formalities. In this article, we delve into the respective responsibilities and distinctions between incorporators, directors, shareholders, and officers. This article is based on the law of the State of Delaware, the most popular US jurisdiction for incorporation.
The corporation must first be registered by an incorporator, whose name and address are specified in the company’s certificate of incorporation . The incorporator’s function can be performed by the founder himself or by a third party, typically a registered agent.
Aside from the corporation’s registration, the incorporator fulfills two other important functions: appointing the company’s directors and affirming its bylaws. The incorporator then relinquishes all of his powers, transfers corporate management to the company’s directors, and no longer participates in the company’s business operations.
There are three key positions in the hierarchy of a C-corp:
The table below illustrates the main differences between these three positions in a C-corp:
Delaware law does not require companies to appoint different people to serve as its directors and officers, so if a C-corp has just one founder, he can serve in all of the company’s key positions. The following sections will discuss each appointed position in greater detail.
Shareholders – whether individuals or legal entities – are the corporation’s owners. There are different paths to acquiring shares of the company. Founders usually acquire shares at a par value purchase price, investors receive shares in exchange for their investments, and employees get shares as a form of payment for their labor. Shareholders do not usually participate in corporate governance unless they are simultaneously appointed as the company’s directors or officers.
Shareholders are provided with certain corporate rights. First, they have the right to elect the company’s board of directors and to amend the company’s bylaws. Shareholders also have the right to vote on fundamental corporate transactions, such as the sale or cessation of the business. Generally, shareholders cast votes at annual meetings, but they can also demand to convene special meetings. Shareholders do not need to physically come to meetings but rather can vote remotely by calling in to meetings or giving their written authorization to others to vote on their behalf in what is known as proxy voting. The number of votes held by a shareholder is usually commensurate with the number of shares he owns. There can be exceptions to this general rule in instances where the class of shares owned by the shareholder does not confer voting rights or confers more than one vote per share.
In addition to meetings, shareholders can make decisions through a written consent signed by shareholders holding a majority of the corporation’s shares. This method is especially suitable for startups where the majority of shares tends to be held by founders, providing a quick and cost-effective method of complying with corporate formalities.
Aside from the right to vote at shareholder meetings, shareholders are also entitled to inspect the corporation’s accounting and financial statements presuming they have a reasonable purpose directly associated with their own interests. In a number of cases, access to financial information is only granted to those shareholders who own a considerable number of shares or who have owned the corporation’s shares for a certain period of time.
Finally, shareholders are entitled to receive dividends if the C-corp declares them. As with voting, the amount of dividends is directly proportional to the number of shares a shareholder has.
The board of directors is the corporation’s main management body. Directors sometimes receive a salary for their work or get reimbursed for expenses that they incur in connection with the performance of their duties at the corporation.
The number of directors sitting on the board and the term of their service are determined by the corporation’s bylaws. Directors hold meetings on a regular basis, as defined in the corporate bylaws, and, where necessary, may convene special meetings. At these meetings, the board of directors discuss issues that impact the company’s business and make decisions regarding the approval of budgets, important transactions, timeframes for the issuance of shares, and payment of dividends. In order to adopt resolutions that affect the company as a whole, the board meeting must have a quorum, i.e. a minimum number of directors in attendance. The precise number constituting a quorum is determined by the company’s bylaws. Directors may also make decisions without holding meetings on the basis of unanimous written consents setting forth the resolutions and signed by all directors.
Delaware law does not obligate a corporation to appoint officers since the board of directors can manage the corporation directly. Nevertheless, the majority of corporations do appoint officers, whose duties and powers are specified in the company’s bylaws or in board resolutions. The typical roster of officers appointed at startups includes President, Chief Executive Officer (CEO), Treasurer or Chief Financial Officer (CFO), and Secretary.
Startups usually have a single individual as their President and CEO. The President is entitled to appoint Vice Presidents, who serve as deputies and make decisions in the President’s absence. The CEO serves as the company’s highest-ranking executive and its most public figure, whose primary duties include managing the company’s operations and resources, making important corporate decisions, and facilitating communication between the board of directors and the company’s relevant departments. The CEO is also responsible for implementing board resolutions and initiatives and for ensuring the company’s uninterrupted operation.
The CFO reports directly to the CEO and is responsible for analyzing the company’s financial and accounting information, preparing budgets, and monitoring costs and expenditures. The CFO must regularly present this information to the board of directors, shareholders, and, where necessary, to the appropriate oversight agencies.
The Secretary is responsible for administering and storing the company’s documentation, including the minutes of shareholders’ and board meetings.
Another position frequently found at a corporation is the Chief Operating Officer (COO), who deals with issues pertaining to marketing, sales, production, and HR. The COO monitors the company’s day-to-day business processes and reports directly to the CEO.
Officers act as the company’s representatives and are responsible for the execution and performance of agreements entered into by the company. When an officer signs an agreement on behalf of the company, the company becomes legally bound by the terms of such agreement. Just like directors, officers are exposed to the fiduciary duties of the corporation and may be held personally liable for any unscrupulous actions taken on its behalf.
Both directors and officers have certain fiduciary duties to the corporation. There are two kinds of such duties – the duty to look out for the company’s interests (duty of care) and the duty to maintain loyalty to the company (duty of loyalty).
The duty of care mandates that directors and officers perform their responsibilities with a due level of prudence and professionalism. Objectively incompetent actions or clear violations of law by a director or officer constitute a breach of this duty. Such actions may result in the director or officer being held personally liable to shareholders for the ensuing damages caused to the corporation. In the case of directors, where decisionmaking is guided by reliable information and rational action, they cannot be held personally liable even if the decision turns out to be wrong or causes a loss. This legal doctrine is known as the business judgment rule.
The duty of loyalty, in turn, mandates that directors and officers act honestly and in good faith with respect to the corporation. First and foremost, this duty prohibits the use of corporate funds for personal gain. A conflict of interest may also constitute a breach of the duty of loyalty if it is not beneficial to the company and has not been approved by the board of directors.
The corporation’s certificate of incorporation may exempt its directors from liability for breaching their duty of care, but directors are always liable for breaching their duty of loyalty.
If a corporation is charged with fraud or tax evasion, its shareholders, directors, and officers are generally shielded from personal liability, insofar as a corporation is treated as an independent legal entity that bears its own legal liability for its actions.
In a number of cases, however, the courts can hold shareholders, officers, or directors personally liable for the unscrupulous actions they have taken on the corporation’s behalf. This measure, known as piercing the corporate veil, may be taken by the courts if the shareholder, officer, or director was personally involved in fraud, wrongdoing, or deceit, has commingled corporate funds with personal funds, or caused insufficient capitalization or financing of the company’s vital operations.