When starting and running a business, many entrepreneurs make the mistake of putting corporate law on the backburner. Although you’ll likely have legal counsel to handle the intricacies, knowing the basics can help you make informed decisions and maintain your interests when needed.
Having a grasp of the key concepts of laws that govern finances, taxes, investor and shareholder relations, and lawsuits can help set your enterprise in the right direction.
This article provides an overview of corporate law and discusses the most relevant legal elements for business owners.
What is corporate law?
Corporate law is a set of regulations that govern the ‘rules of the road.’ It affects the dynamics, including the formation, operations, governance, rights, and responsibilities of all parties involved.
This branch of law applies to publicly traded and privately held corporations, with jurisdictions over the following:
- Forming corporations
- Securing capital
- Managing finances
- Entering transactions
- Investor and stockholder relations
- Dissolution
The foundational rules and regulations that cover corporate activities are based on federal and state corporate statutes. Because corporate laws vary from state to state, it pays to hire a local expert, such as a New York corporate lawyer, or similar firms where you plan to incorporate.
What does corporate law cover?
As mentioned, corporate law covers a wide range of business-critical aspects. But these fields are the most relevant for business owners.
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Processes in forming a corporation
When starting a business, one of the first legal steps is choosing and forming a business structure. A corporation is a common structure that creates an entity separate from its owners. Forming a corporation protects the owners’ personal assets if the business is sued. Forming a corporation includes:
- Choosing a business name
- Filing the articles of incorporation
- Creating bylaws, shares and shareholder agreements
- Getting federal and state tax IDs
- Obtaining any necessary licenses
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Raising capital
Corporations can facilitate investment via share offerings, subject to state and federal securities registration, disclosure duties, and accreditation rules on soliciting private equity investors. Having in-depth capitalization tables, shared vesting schedules, pro forma projections, and thorough operating agreements with investor rights spelled out keeps transactions compliant.
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Corporate governance
Corporate governance refers to the systems and rules in place to govern decision-making and accountability in a corporation. As a business leader, it’s important to establish policies, hierarchy, voting procedures, dispute resolution processes, and bylaws to provide a framework for smooth operations. Good governance helps owners maintain control and prevents misunderstandings down the road.
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Shareholder rights
Shareholder rights cover the basic privileges and powers given to those who own shares in a corporation. Common shareholder rights include:
- Voting Rights: The right to vote on major decisions like mergers, dissolutions, and board elections.
- Dividend Rights: The rights to share profits distributed to shareholders.
- Pre-emptive Rights: The right to purchase newly issued shares before they are offered to new shareholders. This prevents dilution of ownership.
- Access Rights: The right to access financial statements and incorporate records.
- Litigation Rights: The right to sue the corporation for violations of shareholder rights.
- Sell Rights: The rights for shareholders to sell their corporation shares to buyers.
Shareholders have the right to examine corporate documents and sue the corporation for breach of duty or injury in an attempt to protect its interests.
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Board of Directors’ role
A corporation’s board of directors holds important governance powers and decision-making authority, such as overseeing operations, selecting executives, issuing dividends, evaluating policies, facilitating shareholder meetings, and others. As a shareholder, understanding the directors’ scope of duties helps business owners strengthen oversight of their interests in the company.
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Provisions for liability protection
Forming a limited liability company (LLC) or a corporation will help owners separate business and personal assets (e.g., houses, individual bank accounts, and other types of properties). This helps preserve the latter in case the business is sued.
Corporations have greater court precedents upholding their liability barriers for shareholders than LLCs. But generally, careful formation, governance rules adherence, correct insurance, and preventing undercapitalization preserve liability limits for both.
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Navigating securities Laws
When raising investment capital, issuing stock options, or allowing share trades, private corporations must comply with relevant state and federal securities laws regulating equity transactions. Key laws include registration requirements for issuing new securities and mandatory disclosures to potential investors related to business operations and financials.
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Mergers and acquisitions
As a business grows, merging with or acquiring another company may become advantageous. Corporate mergers and acquisitions require adherence to procedural legal steps and financial reporting rules. Owners should understand merger transaction processes, business valuation methods, due diligence, integration planning, applicable taxes, and required state and federal filings to avoid liability risks.
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Ongoing compliance
Beyond formation, governance, financing, and transactions, corporations must adhere to rules related to:
- Conducting shareholder meetings
- Retaining corporate records
- Issuing financial reports to shareholders and regulators
- Obtaining audits
- Disclosing conflicts of interest
- Registering for taxes
- Maintaining licenses, registrations, and formalities to preserve limited liability protections.
Reminders on ethics compliance for management uphold good governance. This, in turn, provides shareholders with redress, transparency, and input channels, thus preventing most common dispute triggers.
Why business owners need to learn the basics
Entrepreneurs without law degrees can benefit from learning basic corporate law tenets, especially when considering scaling the business. Take entity structuring, for example. Choosing between forming an LLC or other corporate entities requires knowing their differences and nuances.
An S-corporation, for example, has different tax schemes and funding access from a C-corporation. At the same time, non-profits are exempted from paying federal taxes. Each corporate model also has different stock practices, protections, restrictions, and worker benefits.
Issues of viable fundraising also intersect with corporate compliance. Corporations allow founders to raise private equity financing in legitimately regulated ways. However, this requires adherence to specific securities laws around investor disclosures. Limited liability companies offer fewer options here because they can’t issue stocks. Knowing the difference allows appropriate choices.
Furthermore, a baseline understanding of governance requirements helps founders implement smart operating policies upfront that retain control for themselves and lay out dispute resolution mechanisms. Setting those baselines prevents power struggles down the line.
In transactions as critical as mergers or sales, legal literacy empowers entrepreneurs in negotiations by:
- Understanding what fair valuation includes
- What steps are needed contractually
- Their tax obligations
- Filings that must be submitted
Ultimately, informed leaders make decisions that best balance their interests with obligations. It helps them comprehend compliance environments critical for accessing capital and avoiding liability landmines. It’s common knowledge that amateur errors prove costly. Learning the basics helps businesses avoid the common legal pitfalls around corporate law, which covers several aspects of a corporation.
The bottom line
Mastering corporate legal formalities may seem optional for a business owner, but governance and compliance impact financing, taxes, investor relationships, liability protection, and more.
Seeking basic legal literacy in formation requirements, governance policies, securities filings, shareholder rights, and mergers and acquisitions helps owners make informed decisions and avoid preventable legal issues as a corporation. With key legal concepts understood, owners can focus on business success while protecting their interests.
