So, you formed a new business entity – congratulations! Voting, management, distribution, liquidation, and other rights are established in the operating agreement, corporate bylaws, partnership agreement, or whatever other type of governing documents exist for your entity. Those types of documents generally deal with administration and governance matters from a high-level procedural standpoint, things like:
- How do you provide notice of meetings?
- How are votes taken?
- What percentage vote is required to approve actions (ordinary vs. extraordinary)?
Your founder/governance documents will rarely get into the weeds on specific compliance requirements and annual filings. Most LLC Operating Agreements say something like, “The Manager shall prepare, or cause to be prepared federal, state, and local tax filings, as well as apply for all required licenses and permits …” If you need to know when those filings are due or what those licenses are (FYI, in Texas many industries are licensed through the Texas Department of Licensing and Regulation (TDLR)), you’re on your own, which is likely why you found your way to this article.
In this article, we’ll look at annual compliance and filing requirements for limited liability companies (LLCs) and corporations in both Texas and Delaware (two states where I’m licensed as a business lawyer and two states where a lot of entities are formed – Delaware because it’s the hub of corporate law in the U.S. and Texas because it’s so darn large, growing, and business favorable). Along the way, we will touch on other alternative entities, such as partnerships – general, limited, and others.
We will also explore some best practices for managing and governing your new entity to get the most out of it and to avoid risks of the entity not providing you the legal protection you expect it to provide.
If you are still trying to decide what type of entity to form, the information in this article may be helpful, although the following article will give you a quick, more tailored overview for deciding between an LLC and a corporation read 4 Things to Know When Deciding Between an LLC or Corporation.
What is Corporate Governance?
Forming a business is an exciting time for any entrepreneur, although the actual day to day operations of a business can be confusing and often a whole lot less exciting. Even more mundane than some aspects of operations are matters involving corporate governance.
Corporate governance is the term for maintaining and operating your business in a manner that complies with legal obligations, including obtaining the appropriate votes and documenting meetings and decisions of the governing bodies (e.g., shareholders and directors for corporations, members and managers for LLCs, partners (general and limited) for the various types of partnerships).
The requirements for corporate governance vary from entity type to entity type and from state to state (BTW, it’s common to use the term “corporate governance” even when referring to an entity other than a corporation, e.g., an LLC, public benefit corporation, limited partnership, etc.)
Generally speaking, corporations require greater attention – more meetings or actions by written consent (an action by written consent is a fancy term for decisions taken in writing via resolutions rather than in an actual meeting) compared to limited liability companies and partnerships. This is true in Texas, Delaware, California, Florida, and every other state I’ve seen, and it is one reason why business attorneys suggest limited liability companies as the right fit for some startups, especially businesses that aren’t intending to grow into large businesses. LLCs don’t fit every startup’s profile and needs, although for relatively small, lifestyle-type businesses, they can be perfect, partly because they can be formed in a way that minimizes the required ongoing maintenance and administration, making the meeting and record-keeping requirements much more relaxed compared to corporations.
Observing corporate formalities is important, even for one-person entities (sole stockholder corporations or sole member LLCs). Failing to pay attention to formalities can create tension among owners and shareholders (assuming a multi-owner business), cause challenges if you want to sell the business when the buyer gets into due diligence, delay or even deter new investors from putting in capital, and possibly create liability for owners as to third parties. For all these reasons, though it’s not exciting, it is important for all business owners to observe corporate formalities if they operate their business out of an entity.
And, keep in mind that corporate governance isn’t just about reducing risk. It’s also about managing important relationships well. If you’re the CEO of a small corporation that raised some outside equity capital, communicating with your investors on a regular basis is good business – the annual shareholder meeting requirement ensures that you formally update them at least once per year (you should do it more often than that – informally, at least). We recommend shifting your mind sight from thinking of these practices as a necessary evil to great business management.
Why Every Business Entity Needs a Founder/Partner Agreement
With limited liability companies, the key agreement among the owners is called an Operating Agreement, Company Agreement, or an LLC Agreement, although the name doesn’t really matter – they all describe the same, formative document for an LLC. With a corporation, it’s the Bylaws or Stockholders Agreement. With partnerships (limited partnerships, limited liability partnerships or general partnerships), it’s called a Partnership Agreement (or Limited Partnership Agreement, etc.). To keep things simple, we just refer to all these types of agreements as “founder or partner agreements.”
A thorough founder/partner agreement lays out the rules for operating and governing the entity – how the owners make certain decisions, when they hold meetings and how they conduct those meetings, how the owners vote, the percentage requirement for a vote to action, and with respect to similar company actions.
The default business laws of a state establish the way things work if there is no founder or partner agreement. In Texas, business attorneys spend a lot of time in the Texas Business Organizations Code (the TBOC). When it comes to Delaware, the Delaware General Corporation Law (DGCL) reigns supreme. These codes and, to some extent case law, define the rights, roles, and requirements among managers, directors, and owners of entities. But, often (nearly always when it comes to an LLC), the involved parties can choose to override the default statutory rules. The Operating Agreement in an LLC is “the deal,” which is why you may hear lawyers say that “LLCs are creatures of contract.” Less pretentiously, that just means that the members and managers of an LLC are free to decide exactly how their LLC should be administered.
Even if the governing law where your entity is domiciled doesn’t require a written founder or partner agreement (Texas, for example, doesn’t require a written Operating Agreement for an LLC), from a best practices standpoint, having one is a must, especially if there are multiple owners.
For LLCs, an Operating Agreement defines member roles (and manager roles if the LLC is manager-managed), establishes voting requirements and procedures, lays out how allocations (of income or loss) and distributions (of cash or property) are performed, and specifies operational and tax-related procedures.
While Texas does not require its LLCs to have an Operating Agreement, Delaware does. The Operating Agreement can be implied, written, or oral, and isn’t filed with the Delaware Secretary of State – it’s a private, internal document.
Corporations generally rely on corporate Bylaws that regulate the entity and its operations. The corporate Bylaws sets out rules for the Corporation’s conduct. Both Texas and Delaware require every corporation to have Bylaws. You do not need to publicly file the Bylaws in either state, but you must create, retain, and follow them. Oftentimes, we’ll prepare a Stockholders Agreement or Voting Agreement, which are contracts that address things that don’t necessarily fit neatly into Bylaws, e.g., a buy-sell agreement among only certain stockholders.
There is no legal requirement in either Texas or Delaware for a general, limited partnership, or limited liability partnership to have a written partnership agreement. In fact, when it comes to a general partnership, all that is needed to form one is the thing every first-year law student learns as the basis of a contract – a meeting of the minds, an intent to form a partnership. Still, it’s always risky to operate a partnership without a written agreement that spells out the terms of the partnership. I have my own unique take on reasons to create a partnership agreement The Most Important Reason to Create a Business Contract or any other business contract that I suggest you read.
Regular and Special Meetings of Shareholders and Boards in Corporations
Corporations formed in Delaware and Texas need to hold at least one stockholders agreement per year (every 13 months in Delaware, actually). This applies to all corporations, including small family-run businesses (although not to “close corporations,” which are a special type of corporation created by statute in some states). Not doing so may give an opportunistic plaintiff’s lawyer a claim that the corporation isn’t observing required formalities and that the veil of the corporation should be “pierced” to allow creditors to sue the shareholders/owners in their personal capacities. This doesn’t happen often, although the argument to do it is made fairly regularly in litigation and you want to be sure not to have trouble defending a claim for veil piercing.
The annual meeting of a corporation is for the purpose of electing directors and transacting any other proper business. Officers and directors who are active in the corporation may view the need to hold a formal stockholders’ meeting as a formality and a hassle. If that’s what you’re inclined to think, keep in mind that stockholders who are kept informed and believe that company management is being transparent and respectful (investors are due a certain amount of attention for putting in the capital and taking a risk, although many owners still fail to maintain adequate investor relations) are likely to be less litigious – part of what drives many lawsuits is that the plaintiff simply feels wronged. In this way, annual or other regular meetings are good governance and risk mitigation generally, which makes them a best practice even when they are not technically required.
Additionally, though not required, there should be regular meetings of the board of directors, as well (at least annually, although that may not be sufficient depending on the context and specific entity. We generally recommend quarterly corporate board meetings for private companies). You should keep notes and turn the notes into minutes for each meeting, which should be made available for inspection by shareholders and directors.
Member and Manager Meetings in Limited Liability Companies
Unlike corporations, neither Texas nor Delaware law require LLCs to hold annual meetings or maintain minutes of meetings if they are held – this holds true for members and managers (FYI, LLCs don’t always have managers). The Delaware LLC Act defers to the LLC Agreement, which may require meetings or may be silent, in which case technically none are required.
Even though there is no statutory mandate for meetings, LLCs with multiple owners should hold regular meetings (member and/or manager), adopt resolutions, and record minutes. All major decisions of the entity should be memorialized, either through resolutions or unanimous written consent in lieu of meetings, and kept in a corporate record book. Doing this creates a record of conversations, which can be helpful when someone misremembers a conversation or challenges a company action.
No Matter What, Adhere to the Requirements in Your Governing Documents
As we discussed in the beginning of this article, your governing documents might already require that you hold a certain number of meetings, so read those carefully. If you don’t have any of these documents, get in touch with us and we’ll help you determine what you need.
If you don’t want to take our advice to hold regular meetings and your governing documents require them, amend your governing documents. It’s one thing to intentionally choose to not employ best practices; it’s another to create a pattern and record of not doing what your governing documents say you must do.
If you haven’t formed your entity, give your attorneys plenty of input into what you consider to be an acceptable amount of governance and record keeping. We clearly believe more is better, although we aren’t fans of committing to procedures on paper that you won’t honor in the real world. Be sure your attorney understands what you are committed to doing and what you aren’t committed to doing. If you’re operating your business as an LLC with one other member and neither of you wants to ever hold a meeting, be sure your Operating Agreement doesn’t require meetings.
What Types of Things Should You Put in your Board and Other Meeting Minutes?
Though you can, you do not need your corporate lawyer to attend private company board, stockholder, member/manager or other meetings to take minutes. Minutes don’t need to be written formally with a lot of flowery legalese.
Here are some things we’d typically include in any meeting minutes:
- The type of meeting (board vs. shareholder; regular (planned) vs. special vs. organizational, which is the first meeting of a new entity)
- The legal name and domicile (state where the entity is formed/kept) of the entity
- The date of the meeting and the start and end times
- The attendees, including their titles/relationship to the company
- The location of the meeting
- The business of the meeting, including any formal vote or action taken and how each person voted (or, you can just say that an action was approved by unanimous vote if no one voted against it)
The Secretary or Chairman of the Board (or Chairman of the meeting if neither of the other two attends) typically signs the minutes, although it’s a good idea to have all the board members do so in the case of a board of directors meeting.
While Texas requires its corporations to keep regular meeting minutes, Delaware does not. These minutes do not need to be filed with the state, but they should be kept with your corporate records.
What Records Do You Need to Keep for Various Business Entities?
Maintaining accurate and complete records is always a best practice. And, some record-keeping is required by law. If you fail to maintain accurate records, you may expose yourself to unwanted future conflict and liability.
Delaware is one of the few states that does not statutorily require the keeping of specific books and records. However, that doesn’t mean you don’t need to keep any books and records. Stockholders have a right under Section 220 of the DGCL to review books and records, which at the very least would generally mean a stockholder ledger (list of stockholders).
Texas law requires that every entity keep books and records of accounts, a current record of the name and mailing address of each owner of the entity, and certain other books and records as required by the applicable section of the Texas Business Organizations Code.
Texas law requires that LLCs maintain a copy of the following at the company’s principal place of business:
- a current listing of the percentage or other interest in the LLC owned by each member
- a copy of LLC federal, state, and local tax information or income tax returns for each of the six preceding tax years
- a copy of its certificate of formation (including any amendments), a copy of its company/operating agreement (including any amendments)
- an executed copy of any powers of attorney
- a copy of any document that establishes a class or group of members, and
- unless contained in a written company agreement, a written statement of the amount of cash contribution and a description and statement of the agreed value of any other contribution made or agreed to be made by each member
The records must be retained in a written form or in another form capable of being converted to a written form in a reasonable time (electronic records).
Miscellaneous Best Practices for Corporate Governance
While not necessarily required by Texas or Delaware statutes, consider the following actions best practices for administering a business entity:
- Maintain accurate, up-to-date stock/equity ledgers. There should be a stock ledger detailing the original issuance of shares and each transfer thereafter. A list of both current and past shareholders, including names and mailing addresses, outlining the number and class of shares held by each shareholder needs to be maintained on an ongoing basis.
- Maintain separate business bank accounts. Your business should have a separate bank account, and you should avoid any commingling of personal and business funds. Use business expense accounts and business reimbursement protocol for all money spent on behalf of the business.
- Operate under the business name. You should always conduct business in the name of the entity, so that it is clear that the members, managers, directors, or officers are acting on behalf of the entity and not in their individual (personal) capacities.
- Keep up with taxes and licensing requirements. Of course, you need to pay all applicable federal, state, and local tax returns and pay taxes when due, as well as obtain all necessary permits and licenses. Failure to do either of these things can result in major consequences.
- Adequate Capitalization. Your business should be capitalized adequately and maintain appropriate operating capital. That’s important for business success, although in this context, we’re talking about it because capitalization is a factor courts consider when determining if it’s appropriate to pierce the veil of an entity. Proper capitalization begins when you form the entity – you should put money into the new business bank account. What constitutes adequate capitalization depends on what your business does. If you operate a one-person marketing firm, it doesn’t need to be much. On the other hand, if you’re manufacturing products, handling hazardous materials, or doing anything else that exposes people to serious risk (even if you take all necessary steps to mitigate that risk and insure against), courts will expect you to be more well-capitalized.
- Proper and Sufficient Insurance. One main reason that business owners form entities is to protect themselves from personal liability. Following applicable requirements and the best practices we set out in this article will help ensure the liability protection feature of your entity holds up. However, don’t forget about insurance. When something goes wrong, especially when it goes very wrong (e.g., someone is seriously injured or dies), an aggressive plaintiff’s attorney who finds that the entity they are suing has few (or no) assets, will bend over backwards to find a reason to sue the officers and owners. It’s possible, of course, that they cannot justify a claim against people personally and do not try. Often, though, they will come up with some claim to name officers and directors individually. If you’re named in a lawsuit, it can take time and money to get you out of the lawsuit even if the claims lack merit. Insurance helps here. What the plaintiff’s attorneys are looking for is some pockets with money. Of course, your insurance company won’t be interested in cutting a check for a weak claim, although it may handle the defense, so you don’t have to pay out of pocket and it will divert attention from the owners personally.
- Be careful of giving inadvertent personal guarantees. Don’t sign a business contract in your personal name unless you intend to personally guarantee the agreement. You may need to personally guarantee a loan or commercial office lease, although most vendors/suppliers will let you sign in your capacity as an officer, manager or other formal position with your company (not personally). When you sign in your company capacity, your title will be listed under or next to your name, whereas when you sign personally, the signature line will look something like this:
Name: Maverick Mitchell, individually
Compare the personal signature line (lawyers call it a signature block) to the following company signature block:
TOP GUN, LLC
Name: Maverick Mitchell
Besides not wanting to expose yourself personally, if you personally guarantee lots of company debts, courts may consider you to be acting as an alter ego of your entity. This is one more factor that could lead to the entity losing its separate entity status (which is what protects owners from personal liability). You may feel that you need to do what you need to do to get the credit you need to grow, and we do not consider this (too many personal guarantees) to be a huge risk. Still, it is one more thing to consider, and one way to mitigate risk is to always formally document a company action (minutes documenting an action in a meeting or an action by written consent) approving of the personal guarantee(s) for the specified purpose.
- Be clear and intentional about your authorized signatories. Adopt a resolution that authorizes specific people to sign contracts that bind your company, and then enforce the rules by letting only authorized signatories sign documents.
Registering to Do Business in Other States
Once your business has a certain amount of contact and activity in a state other than where the entity is domiciled (the state under whose laws the entity exists), you will need to file to do business in that state. This is usually called registering as a foreign entity. The word “foreign” is confusing, although, in this context, it simply means an entity that was not form/organized in that particular state. In Texas, registering as a foreign entity requires a one-time $750 fee. FYI, you will need a registered agent in any state where you need to register as a foreign entity.
Tax and Other Filing Requirements
As an owner of a business entity, it is critical to know and understand the steps necessary to maintain “good standing” within your state of formation. Good standing is the status your entity holds by being in compliance with the maintenance requirements within your state. If you fail to keep your entity in compliance, the state could charge penalties or even administratively require the dissolution of the entity.
There are many ongoing requirements that you must comply with, including annual government reports/returns and fees, notice of a name change, notice of a change of primary office address, notices of change of registered office, and others. The chart below outlines some of the ongoing maintenance requirements for Texas and Delaware entities.
Speaking with a Business Lawyer
If you want to speak to a corporate/business lawyer, reach out to us. We have offices in Austin and Houston, although we help entrepreneurs and business owners all over Texas and the United States. We look forward to connecting with you.
Author: Brett Cenkus
Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.