You’ve decided to start a business. Congratulations. Perform a bit of research and you will quickly realize the need for a business entity. The question then becomes do you use an online service such as LegalZoom or an incorporation attorney?
Apples and Oranges
Given that I am an Internet attorney, you are undoubtedly expecting a diatribe about why the LegalZooms of the world are the ultimate evil of all evils. Many of my peers would certainly take this position. The question really misses the point. The service provided by an attorney versus an online incorporation service is really a matter of apples and oranges. [For the purpose of this article, “incorporation” will refer to both corporations and LLCs.]
LegalZoom provides the “outer shell” of a business entity. The company files the articles of incorporation necessary to register your business with the relevant state and then sends you a corporate book to hold the document. The problem is the formation process requires so much more from a legal perspective. Commonly required tasks include:
- Registration of securities,
- Negotiation and preparation of shareholder agreements,
- State corporate department filings,
- Creation of minutes,
- Creation of bylaws or operating agreements,
- Negotiation and preparation of buy-sell agreements,
- Issuance of shares, and
- Financing documentation.
Online incorporation services cannot perform these tasks. Doing so constitutes the practice of law, which these services are forbidden to provide to the public. The best such services can do is to give you blank forms and instruct you to handle the filings on your own. The problem is you have no idea how to fill out the forms, if you have all the forms necessary, or the legal implications of providing particular answers.
For example, California requires all corporations to register the sale of shares with the California Department of Business Oversight. The registration process is handled online through an interview format. Given the interview format, there is no form LegalZoom can provide for you to use. Many people forming businesses fail to register at all because of this – a clear and potentially expensive violation of the law. If your corporation or LLC is named as a defendant in a lawsuit, the suing attorney will argue such a failure invalidates the business entity. If the judge agrees, the corporation or LLC will be set aside, and you will be held personally responsible for any subsequent judgment.
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Each year, business attorneys are introduced to at least one company that has the same problem. The founders of the enterprise formed their entity on the cheap. The business formation documentation consists of a corporate book, a copy of the articles of incorporation and a number of tabs filled with blank forms or no documentation at all. There are no minutes. No bylaws or operating agreements. The company has not even issued shares to the founders.
After spending a good amount of blood, sweat, and tears on building the company for five years, the founders are now fighting. Such disputes are incredibly common. The reason might be an issue as complex as determining whether the company should form a joint venture agreement with another major company that could result in either total disaster or massive revenues. In other cases, the founders may just have grown sick of each other. Whatever the reason, the business is paralyzed by the dispute.
A founder breakup is much like a divorce. If the founders are lucky, they may come to their senses and work out an agreement for one person to leave with a payout. This common sense outcome rarely occurs. Emotions are running too high. A more likely outcome is the founders end up each hiring legal counsel and spending a year in court fighting over substantive and perceived issues until the parties either run out of money or the judge decides the matter. Neither outcome is optimal.
Perhaps the most aggravating aspect of this common scenario is it can be easily avoided. A shareholders agreement can be used to address these issues including when and how a founder may be bought out. The agreement should be negotiated prior to forming the company – before money and personal issues cloud the matter.
The cost of creating a founders agreement is roughly $2,000 to $4,000 depending on the negotiations. The fee pails in comparison to the $100,000 or more founders will spend suing each other. The math suggests saving a few bucks up front by using an online incorporation service doesn’t make much sense in the long run.
Pay Me Now or Pay Me Later
I must admit to getting a good chuckle when I see a LegalZoom commercial on television. The actor and voice over suggest forming a corporation or LLC is a simple as filing a form with the Secretary of State. The truth is you can file articles of incorporation just as easily as LegalZoom in most states. The devil is in the details when it comes to correctly setting up a business entity. The concern is that if you use an incorporation service, you may believe protections are in place that really do not exist because of errors in the formation process. Unfortunately, you will only learn of these defects once the business is sued, and you are personally exposed to any resulting judgment.
The old cliche is you can pay me now, or you can pay me later. This concept certainly applies to the incorporation process. There are simple situations where forming a corporation or LLC through an online service is acceptable. Unfortunately, such scenarios are few and far between. You can use LegalZoom to form your business entity. Just make sure you retain an attorney afterward to make sure all the securities and corporate requirements are met.
Richard A. Chapo, Esq.