Forming a Business Entity: Lawyers vs. Document Creation Sites
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Hi, I’m Neil Fridman, Esq., Managing Partner of Fridman Law Firm. So I’m often asked: “Should I incorporate or form my entity using a service like LegalZoom or IncFile or Stripe Atlas?” There’s so many of these companies out there. And there’s nothing wrong with these companies. They will form your entity properly but what they don’t do is give you guidance in 2 important ways. 1, whether you should be an LLC or a C-Corp for instance… These are key decisions that if you don’t get right at the outset, you may end up having to correct later on. And correcting later on is a much much more difficult process and could be more burdensome as well as expensive in legal fees. The reason I say this is because an attorney is skilled in assessing the different factors that each founder brings to the table in terms of which entity they should be choosing. So a founder may want to be an LLC for one reason and not a C-Corp for another, but that reason may not be the best reason or reasons to focus on.
The second problem I have with these companies is they give you off-the-shelf forms for let’s say if it’s an LLC, an operating agreement, or bylaws if it’s a C-Corp. The issue that I have with these is that a form agreement is exactly that - it’s a form. It’s not specific to your needs and your relationship with your other founders or other employees of your company for example. So what I see a lot is companies that come to me and say: “We formed our company with XYZ service (whether it’s LegalZoom, or IncFile, or whatever it might be), and now we have some sort of disagreement between the parties.” So I say: “OK, if you’re an LLC, show me your operating agreement.” And the operating agreement would have these basic provisions in there that don’t fully address (or don’t address at all), what happens if there’s a disagreement, what are the rights and responsibilities of the parties, etc. When a client comes to me and I form an entity, I don’t charge them for the formation of an entity -- that is done by my corporate services company. What I charge them for is drafting these documents: operating agreement, shareholders agreement, for example.
And the reason why I spend a lot of time going into detail with founders about this is because an operating agreement or shareholders agreement is something that the parties at the outset want to get right but never have to necessarily look at again. Meaning that they know what the rights and responsibilities of the parties are. So I’ve had a number of situations over the years where a very successful startup will come to me in Year 1 or 2 and it may have been founded by two friends, for example. One is a CEO or CTO or COO and there’s a disagreement. They say: “What can we do about this?” If the CEO is saying to me: “Well I can’t agree with my co-founder on XYZ issue - what do I do?”
And I look at these documents from one of these services and the form documents just do not spell out clearly what happens if there’s a disagreement, if there’s a deadlock, etc. And when a client comes to me and they want to form a company, I get to know them, I get to know their co-founders and I learn what everyone’s rights and responsibilities are. And I draft in those documents provisions that explicitly say what happens in the event of a deadlock for example. If the parties cannot agree, how does this play out? And it’s very specific and there’s mechanisms in there to provide for what happens in the case of a disagreement. Is there a cooling off period? How long do you have to wait before taking some action or going to mediation, arbitration? Or should this be heard in front of a jury? Those things are sort of at the extreme cases where you have a fundamental disagreement that you just can’t overcome. But even if you’re looking at a less extreme example where you just don’t know who is supposed to be doing what, that is why it’s very important to have that either in a basic founders agreement or operating agreement or shareholders agreement. To be able to spell these things out so that that document is something that you and your co-founders understand when you’re drafting it. Everyone knows what they need to be doing, they know what happens in the case of a disagreement and that gets filed away and you don’t have to look at it. Should there be any type of disagreement then you would bring that out but everybody would already know, having spoken with counsel that advised them on this what to expect in that type of situation.
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