The concept of entity formation and protection of personal assets is a common topic that is thrust in front of business owners at all stages, from a startup to a third-generation family business. This concept of asset protection seems to be everywhere today, but simply forming an entity is not enough to provide the desired protection.
Forming the entity is similar to building a house, in that building it is only the first step, and you’ll need to maintain the house and the entity going forward. Many owners overlook the maintenance that entities require. The failure to properly maintain appropriate corporate formalities can erode protections created by the formation of the entity. Conducting maintenance on the entity from time to time can help preserve the operations of the business and pass the protection onto future owners.
The type of required maintenance varies depending on the type of entity. For a corporation, you are required to hold annual shareholder meetings. At the annual meeting, the shareholders are required to elect the corporation’s directors and address other business needs. The meeting may be replaced by a written consent signed by a majority of the shareholders (if the articles of incorporation permit).
Under the Michigan Business Corporation Act, upon request from any shareholder, the corporation can be required to mail shareholders the corporation’s balance sheet, as of the end of the preceding fiscal year; the corporation’s statement of income for the fiscal year; and, if prepared by the corporation, its statement of source and application of funds for the fiscal year.
In addition to the annual shareholder meeting, the board of directors should meet at least once a year to elect officers of the corporation. Additionally, the board of directors should meet throughout the year to address other issues that may arise. Corporations should maintain a stock ledger of all issued and outstanding shares and make sure the appropriate stock certificates have been issued and can be located.
Finally, there may be unique provisions in the bylaws or other governing documents that require a corporation to take action throughout the year: review corporate documents, create a list of to dos and monitor your progress regularly.
For a limited liability company, the Michigan Limited Liability Company Act does not require an annual meeting of the members. However, the governing documents for the entity, such as the operating agreement, should be reviewed to determine what requirements, if any, are included in the entity’s governing documents. For a partnership, or other types of entities, you should also review the governing documents to determine what specific requirements there are, if any, for the entity on an ongoing basis.
Finally, if you have a shareholder agreement or separate buy-sell agreement among the equity owners, you should review that agreement to determine if there are any ongoing obligations under that agreement. In some cases, that agreement will require parties to agree annually on a valuation for the entity or to obtain a valuation. The requirements of these agreements should be followed to avoid any future complications.
Knowing what has to be done is only half the battle; you also need to follow through on these requirements. Similar to a spring cleaning, try to select a particular time of year to tackle these maintenance issues and get into a routine year after year. Keep in mind providing advanced notice is often required for many of these meetings. Therefore, set a meeting schedule to help ensure the proper level of attendance and participation.
The failure to maintain your entity can lead to liability and a loss of protection. Failure to follow the corporate formality established in your entity could be a factor a creditor can use to pierce the “corporate veil” of limited liability, thus holding you personally responsible for the liabilities of the entity. In other words, if you fail to properly maintain the entity, you are in danger of losing the protection of the entity.
In addition to preserving the protection from the liability gained by the formation of the entity, there is a variety of other benefits you can achieve by properly maintaining your entity:
Communication of information: An annual meeting of the equity owners provides an excellent opportunity for management to communicate information to the equity owners regarding the strategic vision and mission of the entity.
Family meeting: For a family-owned business, a shareholder meeting may precede or follow a family meeting.
Strategic planning: An annual meeting can be useful to review or develop a strategic plan.
Separation of duties: Holding an annual shareholders meeting where shareholders elect directors and then an annual directors meeting where the directors in turn elect or appoint officers helps to clearly remind stakeholders of their duties to the organization. In a closely held or family-owned business, often the lines between shareholder, director and officer can be blurred, as some people wear all three hats. Holding appropriate meetings and following the proper processes can help remind individuals of the role they serve and the rights/duties of each role.
Review of governance matters: An annual meeting also can provide time to review the governance policies of the entity to ensure the policies are consistent with the entity’s policies and procedures. These meetings can spur discussion and thoughtful review of governance matters.
Very few things in life are maintenance-free, and unfortunately, your entity is not one of those. However, with a focused effort and consistent planning, you can successfully maintain your entity and extend its benefits to future owners.
Matthew D. Johnson is an attorney with Warner Norcross & Judd LLP. He represents closely held and family-owned businesses with corporate and transactional needs, from commercial contracts to strategic planning, including buying and selling businesses. Matt can be contacted at 616.752.2529 or email@example.com.