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Startups Entering the U.S. Market 101 (1) - Incorporation (ENG)

2020. 9. 14.

In the upcoming series, we will review the necessary procedures for startups to establish a corporation in the United States as well as the legal factors that should be considered. (Note that the following information is written with the intent to provide general information only and not intended for legal advice for specific clients. Please consult a lawyer before taking any action based on the information.)

Types of Corporations

If a startup decides to establish a corporation in the United States, it must first decide between a C corporation and an S corporation. (It is possible to establish a Limited Liability Company, but this article will focus mainly on the establishment of a corporation.) If a startup plans to issue only one class of stock and has no more than 100 U.S. individual shareholders, it may consider an S corporation. However, most startups that plan to enter the U.S. after establishing a company in their home countries first generally choose the C corporation. There are several detailed differences, but in short, the main difference between the two types of corporations is how the Federal Tax is imposed. C corporations are double taxed at the corporate level and the shareholder level, while S corporations are generally only taxed once at the shareholder level. Considering taxation alone, one might think that incorporating an S corporation is more beneficial, yet one should note that there are many restrictions foreign startups will face as an S corporation.

Selecting the State of Corporation

One of the most frequently asked questions is why the incorporation should be done in Delaware if the office and all business operations will be executed in other states, e.g., California. Essentially, the law of the state in which the corporation is incorporated becomes the basis for the mergers, the duties of directors and officers, shareholders' rights, and other fees and taxes. Delaware’s corporation law is usually advantageous for companies that wish to attain investment from VCs and other entities in the U.S. Also Delaware’s corporation law regarding the cost, procedure, and time setting up a corporation are generally more beneficial compared to other states. However, if a foreign parent company holds 100% of the stake or if a company has no plans to attract investments within the U.S., the advantages Delaware’s corporation law hold may not be as significant. In such cases, managing costs and fees for both Delaware and the state in which all operations will happen may do more harm than good.

Selecting Corporation Name

In the process of selecting the U.S. corporation’s name, it is necessary to ascertain the requirements of the state in which the corporation is going to be incorporated. Certain states prohibit the inclusion of specific words as part of a formal corporation’s name. It would be ideal to review in advance whether the selected corporation name is appropriate in different states the corporation intends to operate the business in the future as well. (Reviewing requirements for all 50 states may be difficult, but it is recommended to take time and review the requirements for a selected few state where major business transactions will occur.) Corporations are also advised to check whether its corporation name can be used as part of a website domain and whether there is a similar trademark registered already.

Drafting Article of Incorporation and Bylaws

It is important to understand that corporations are considered to exist only when the article of incorporation (also known as the certificate of incorporation in some states) is filed with the secretary of state. Newly established startups may draft a very simple article of incorporation, which includes the following details: information about an incorporator, information about a registered agent for service of process, an address of the corporation, the classes of stocks (typically only including common stocks at the time of incorporation), the number of shares, and the par value of the stock, etc. You may also include terms of voting rights, directors’ liability and its limitations, and indemnification, etc.

There is no specific information that a corporation’s bylaws must include. Nevertheless, bylaws should be understood as a general rule and promise that all members of a corporation must abide by and should be written in a detailed language that can be clearly interpreted by all. In general, a corporation’s bylaws include the following detail: information about the board of directors and general shareholders’ meeting, quorum requirements, roles and authorities of directors and officers, issuing stock, restrictions on transfer, and information about dividends, etc.

Charter Filing and Post-Incorporation Procedure

Upon completion, the article of incorporation, often referred to as a charter, must be filed to the state. It can be filed directly or processed through a registered agent. It is essential to keep in mind that until the charter has been properly filed and the state issues the notification of receipt, the corporation is not yet legally established, making it impossible for the corporation to conduct any legal activity in the capacity of the corporation. Once the corporation is properly incorporated, follow up procedures such as issuing common stock to founders, establishing equity incentive plans, and executing proprietary information and invention assignment agreements, etc. To open a corporation bank account, an application for an employer identification number (EIN) is needed as well.

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