Keeping careful records is essential to a well-run business. In fact, if your company is a disorganized mess that ignores corporate formalities, your future could be in jeopardy. Here, you’ll learn how to get things back on track if you haven’t been documenting your business as you should.
What Happens If You Don’t Follow Corporate Formalities?
Let’s touch on three disasters that can brew if you fail to keep proper records. For the purposes of this article “following corporate formalities” means documenting your decisions through resolutions, keeping separate bank accounts for your personal and business funds, and not issuing shares of stock that aren’t authorized in your business’s organizational documents.
1. You Can Lose Limited Liability Protection
Many business owners form a corporation or LLC to protect themselves from personal liability for business-related debts. For example, if you own a rental property in an LLC and someone sues you for something related to your rental, you wouldn’t have to dip into personal funds to pay the judgment. Your liability is limited to your investment.
However, as described in my article on piercing the corporate veil, if a court sees that a business owner has ignored corporate formalities, the court may hold them personally liable for the business-related liabilities. This is bad! It can lead to losing your car, stocks, and personal residence.
2. You’ll Have Trouble Raising Money (Or Selling Your Business)
If you go to raise money in a Series A financing or try to sell your business entirely, potential investors will look under the hood and conduct due diligence. If they see that you haven’t been properly documenting your business, they’re going to think you’re an utter goofball!
Not only will your good name be tarnished, but your potential business partners may back out of the deal. If, out of the goodness of their hearts, they’re still willing to move forward, you’ll need to pay lawyers to clean up your mess and get your business in shape. Meh.
3. Your Business Will Slow Down
Diligently documenting your decisions can prevent delays when dealing with third parties. For example, when you try to open a bank account, the representative may ask you for resolutions authorizing you to open a bank account on behalf of your company.
Preparing the resolutions would have taken 15 minutes at the most. Without resolutions, you’ll feel embarrassed as you grumble out of your chair, drive back to the office (or, in the COVID era, your kitchen counter), type out the resolutions, realize your printer doesn’t work (because printers never work), try to figure out how to print the resolutions at Staples, enter a generally hysterical state, and finally drag yourself back to the bank.
Without proper documentation, you might not even know who your business’s board members or officers are. It sounds ridiculous, but I’ve had several clients who have no idea who is on their board of directors. Their CEO is a mystery. Without properly authorizing your company’s key decision-makers, your business is less empowered to act with agility.
What to Do If You Haven’t Been Keeping Records
Do you feel like you’re in a corporate horror movie? Are your knuckles white from gripping the armrests of your chair, terrified because you hadn’t heard of a corporate resolution until this article!?
Never fear. Deep breaths. Everything will be ok. Here’s how to get your business back on track.
1. Start Documenting Major Decisions
This may seem obvious, but the first step is to commit to respecting corporate formalities moving forward. Draft corporate resolutions to authorize the issuance of shares or stock options. Hold regular board meetings. Go to the bank and open a business checking account.
2. Draft a Board Resolution Ratifying Your Business’s Previous Actions
“Ratification” is a wonderful thing. When the board ratifies previous acts, it basically says: “A bunch of stuff happened in the past few years. We forgot to document it, but now we’re saying that it was all ok and we approve it now.”
DGCL § 204
Delaware has a specific law (DGCL § 204) that deals with ratification. It says your board resolution addressing ratification should include the following:
- The corporate act you’re ratifying
- The date the corporate act took place
- If your issued shares that weren’t actually authorized, the number of shares and the date you attempted to issue them
- Why the corporate act was defective (often a lack of a resolution)
- A statement saying that the board ratifies the previous act
Sample Ratification
For example, if you forgot to record the appointment of officers — Chief Executive Officer, Chief Financial Officer, Secretary — you could write the following:
- We’re ratifying the appointment of the CEO (Stephanie Smith), CFO (Mario Martinez), and Secretary (Liana Li).
- We meant to appoint them on January 4, 2019.
- We failed to appoint them properly because we forgot to draft a board resolution.
- We ratify the appointment of the officers, effective as of January 4, 2019.
You can do this for all sorts of things you forgot to record. Throw them all in a giant resolution and ratify all the major decisions that fell through the cracks.
3. Get Shareholder Approval
As discussed in my article about corporate resolutions, some major decisions require shareholder approval to be effective. These include actions such as:
- Amending the business’s organizational documents
- Entering into a merger or sale of the company
- Adopting or amending an equity incentive plan
- Dissolving the corporation
For example, if you amended your corporation’s Certificate of Incorporation without getting approval from the shareholders, you’re going to have to ask them to ratify the change. The contents of the shareholder ratification document can be similar to the board ratification document discussed in the previous section.
If you’re the only shareholder, this isn’t much of a problem — you can just sign a document saying you ratify the act. If you have a few shareholders, it becomes a bit more of a headache to round everyone up. With a herd of shareholders, it might be best to ask an attorney for help.
4. File a Certificate of Validation (Sometimes)
Business-friendly Delaware has a special certificate you can file to fix your corporate whoopsies.
If you were supposed to file a document with the Delaware Secretary of State and either (i) forgot to file or (ii) filed without getting approval from your board or shareholders, you can file a Certificate of Validation. A properly filed Certificate of Validation means Delaware will treat whatever document you should have filed before as if it were filed on time.
You only need a Certificate of Validation for things like:
- an Amended and Restated Certificate of Incorporation to authorize new shares or classes of stock
- a Merger Agreement
- a Certificate of Conversion
Here’s a sample Certificate of Validation from a public company that is ratifying the amendment of their Certificate of Incorporation. See, even public companies make mistakes!
You do not need a Certificate of Validation for internal matters that don’t require a government filing, such as:
- appointing officers
- amending bylaws
- issuing shares of stock within authorized limits.
Need Help Getting Your Business in Shape?
If all of this seems a bit overwhelming, don’t worry. If you’re unable to get things back on track yourself, a good business lawyer can help you right the ship. We draft resolutions and file certificates all the time. If you have any questions, feel free to reach out!