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Corporate Formalities: A Necessary Checklist for Family Owned Businesses

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An owner-operator of a family owned business often wears many hats (CEO, HR director, sales manager, copy machine repairman, chief coffee maker, etc.). While doing all of these tasks, it is importantto also remember to obey the corporate formalities in order to preserve the liability protections afforded to the shareholders and directors of the Corporation.

At a minimum, the Corporation should have a meeting of the shareholders and a meeting of the directors at least annually. The shareholders are the individuals that own the Corporation. They are not entitled to serve as an officer or employee of the Corporation merely because they are a shareholder, nor are they entitled to any form of compensation for being a shareholder. Shareholders are only entitled to receive annual financial statements and distributions of income when determined appropriate by the Board of Directors (the “Board”).

The main function of the shareholders is to vote on certain corporate matters. The most fundamental voting right of the shareholders is to appoint the Board. The manner in which nominations are made and elections carried out are generally set forth in the Bylaws. In addition to appointing the Board, shareholders are entitled, by statute, to vote on certain other corporate matters (e.g. adopt, amend or repeal Bylaws, ratify or request Board actions and remove Board members).

Once the shareholders have elected the Board, the Board is responsible for creating and executing a plan for the overall success for the Corporation. The Board approves the annual budget, approves the compensation of the president, and helps establish the short- and long-term goals for the Corporation. Directors on the Board may or may not be compensated for serving.

In addition to crafting the vision of the Corporation, the Board is responsible for the appointment of officers (president, secretary, treasurer). The officers serve at the direction of the Board and manage the day-to-day operations of the Corporation. Officers are typically compensated for the services they provide to the Corporation.

In many small family owned businesses, the individual owner-operator acts as the shareholder, director and the president, secretary and treasurer.

While this structure is the simplest from an operational standpoint, it can have negative consequences for the Corporation. For example, if something unexpected happens to the owner- operator, the Corporation may be left without the ability to issue checks, make payroll or carry-on any form of business.

A sound understanding of the various roles individuals can serve in the Corporation also allows the owner-operator to begin developing a succession plan. Over time, the owner-operator can appoint officers to the Corporation that he or she believes can operate the business in the owner-operator’s absence. The officers can work with the owner-operator to manage the day-to-day operations of the business, all while the owner- operator evaluates the capabilities of the individuals. These individuals can be terminated by the Board at any time.

In addition, the owner-operator can appoint individuals to the Board in a formal or strictly advisory capacity to help with big- picture matters impacting the Corporation. These individuals might be family members or outsiders with expertise in particular areas that can benefit the Corporation. These individuals can be removed from the Board by the shareholder.

When the owner-operator believes it is time to formally transition the business, he or she can begin transferring shares to the successor or successors. The new shareholders, once they have a majority of the shares, are then responsible for appointing the Board and continuing the legacy of the Corporation.

Utilizing the corporate formalities and a staged approach to a transition allows the owner-operator to identify and evaluate successors, sets up an emergency succession plan, and can defer the actual sale or transition of the Corporation until the owner-operator is confident his or her wishes for the Corporation will be carried out.

For more information, contact MacDonald Illig Attorneys at 814/870-7600 or info@mijb.com.

Kyle E. Gallo is an associate at MacDonald Illig Attorneys. He is a member of the Firm’s Trusts & Estates and Business Transactions Practice Groups.