Key Takeaways

  • An incorporation agreement, also known as a pre-incorporation agreement, outlines the rights, responsibilities, and obligations of founders before a company is formally incorporated.
  • Key elements often include corporate name, purpose, shareholder contributions, share distribution, and authority to act on behalf of the company.
  • Benefits include clarifying roles, reducing disputes, guiding early decision-making, and establishing accountability among directors and shareholders.
  • Risks of incorporation remain, such as potential liability for promoters if the business is not formed, or dissolution if statutory formalities are not met.
  • Additional considerations include dispute resolution mechanisms, buy-sell provisions, confidentiality terms, and compliance with new corporate reporting rules like the Corporate Transparency Act.

An incorporation agreement is an important document when a company takes steps to incorporate. Also known as a pre-incorporation agreement, it will help prevent misunderstandings about the roles and responsibilities of the principal parties of an incorporated entity.

It sets out such details as the name of the corporation being formed, its purpose, the names of the directors and officers at the time the business is incorporated, share distribution, and even salaries for the directors and officers. With this document, you can confidently enter into agreements and make key decisions prior to the actual formation of your business as a corporation.

The incorporation agreement exists prior to the directors filing formal Articles of Incorporation in the state in which the business plans to be established. The directors, also known as the corporation’s promoters, can be held personally liable for any breach of the agreement should the corporation not actually be formed. Therefore, all parties to the agreement should insist on an acknowledgment within the document that the corporation has yet to be formed. This language will ensure that they avoid any personal liability.

Elements of an Incorporation Agreement

The following terms are found in all incorporation agreements:

  • The name of the corporation that meets the state of incorporation’s criteria for uniqueness.
  • A statement explaining why the business is being formed. This can be general (“to engage in any lawful activity”) or specific as desired, although too specific a statement of purpose can limit the flexibility of the corporation in the future.
  • Business address.
  • Names and addresses of the directors of the corporation.
  • The amount of capital contribution being made by the initial shareholders of the corporation.
  • Identifying who can conduct financial transactions, such as opening bank accounts and signing checks.
  • Assigning authority to conduct business, i.e. sign contracts, conduct negotiations, etc.

It is common, due to the important role an incorporation agreement plays in the creation of a business, that the directors enlist the services of an attorney experienced in contract law.

Additional Provisions in an Incorporation Agreement

Beyond the basic elements, incorporation agreements often include provisions that strengthen the governance and long-term stability of the company:

  • Dispute Resolution: Specifies how conflicts among founders or shareholders will be handled, often through mediation or arbitration rather than litigation.
  • Buy-Sell Agreements: Establishes rules for transferring ownership interests if a shareholder leaves, passes away, or wants to sell their shares.
  • Confidentiality and Non-Compete Clauses: Protects sensitive business information and prevents founders from competing with the new company.
  • Capital Raising Framework: Clarifies how future fundraising rounds will be approached and how additional shares will be issued.
  • Succession Planning: Outlines procedures for replacing directors or officers to ensure continuity.

These additions help ensure that the incorporation agreement functions not only as a starting document but also as a foundation for long-term business operations.

Importance of an Incorporation Agreement

While an incorporation agreement is not required by a state as part of the documents that must be filed to incorporate, it is nonetheless an important step that a corporation’s founders should take. Advantages of the agreement include:

  • Explicit descriptions of the roles and responsibilities of the directors and officers of the corporation.
  • Scope of liability of each director and officer in the event a claim for damages is filed against the corporation.
  • Obligation of the corporation to conduct business according to the statutes of the state in which it is formed.

Legal Consequences and Liability

A properly drafted incorporation agreement also mitigates potential legal risks:

  • Promoter Liability: If the corporation is never formally established, promoters may be personally responsible for contracts signed on the corporation’s behalf.
  • Regulatory Compliance: The agreement can require adherence to federal and state laws, including recent rules like the Corporate Transparency Act, which imposes strict ownership reporting obligations with significant penalties for non-compliance.
  • Binding Commitments: Courts often enforce pre-incorporation agreements to hold parties accountable, especially if substantial reliance or financial investment has already been made.

This ensures that founders operate with clear legal safeguards before filing formal articles of incorporation.

Reasons for an Incorporation Agreement

Of all the types of business entities (sole proprietorship, partnership, limited liability company and corporation), the corporation is the most complex, due to the legal requirements that must be followed to prevent the company from dissolution.

The incorporation agreement provides guidance to the individuals who will eventually form the corporation throughout the early stages of incorporation. Vital shareholder and confidentiality agreements that will impact the operation of the corporation are created throughout this pre-incorporation period.

It is also when key business decisions must be made. The incorporation can grant, and also limit, the range of authority of each founding member. During this early stage, directors actually have the opportunity to clearly assess the actual viability of the success of the corporation. It is not unusual for the decision to abandon plans to incorporate to be made during this critical period. Although it may difficult to do so, it may actually turn out for the best to confront key issues early before the money is spent on legal and filing fees.

Strategic Advantages of a Pre-Incorporation Agreement

Having an incorporation agreement in place before formal registration provides strategic benefits:

  • Alignment of Vision: Ensures that all founders agree on the mission, goals, and direction of the business.
  • Investor Confidence: Potential investors and financial institutions are more likely to engage with a company that demonstrates early governance and clarity in shareholder rights.
  • Operational Efficiency: Provides a clear framework for decision-making, preventing delays in critical early business operations.
  • Flexibility in Planning: Allows parties to test the viability of the business and make adjustments before incurring formal filing fees or regulatory obligations.

This foresight reduces misunderstandings and sets a cooperative tone among stakeholders.

Reasons to Incorporate

As a business owner, you may favor incorporating your businesses for several reasons:

  • Incorporation can provide tax advantages for shareholders.
  • It is easy to transfer ownership of shares of a corporation.
  • A corporation provides advantages for raising capital that other business entities do not.
  • The personal assets of the shareholders of a corporation are protected in the event a claim for damages is filed against the business.

Risks of Incorporation

However, there are risks associated with incorporating a business that you should be aware of, especially during the early stages of incorporation:

  • Banks and financial institutions may require personal guarantees before providing loans or other forms of financial assistance.
  • In the event the corporation commits criminal acts, board members can be held liable.
  • If legal formalities are not followed, the corporation can be dissolved and a board member’s personal assets seized.

The important role that a well thought out incorporation agreement can play in the enduring health and success of a corporation cannot be understated. Don’t skip this important step.

Common Mistakes to Avoid in Incorporation Agreements

Founders often overlook or mishandle aspects of incorporation agreements, leading to problems later:

  • Vague Terms: Ambiguities in share distribution, authority, or responsibilities can lead to disputes.
  • Failure to Plan for Exit: Omitting buy-sell or transfer clauses may result in shareholder deadlock or forced sales under unfavorable terms.
  • Ignoring Dispute Resolution Mechanisms: Without pre-defined procedures, disagreements may escalate into costly litigation.
  • Non-Compliance with Law: Overlooking new corporate transparency or filing requirements may expose the corporation and its founders to penalties.
  • Overly Restrictive Clauses: Provisions that are too limiting—such as excessively narrow purpose statements—may restrict future growth opportunities.

Careful drafting with professional legal guidance can help avoid these pitfalls.

Frequently Asked Questions

  1. Is an incorporation agreement legally required?
    No, most states do not require an incorporation agreement to file Articles of Incorporation, but it is strongly recommended to protect founders and clarify roles.
  2. Who signs an incorporation agreement?
    Typically, the incorporators or promoters of the business sign the agreement, along with any initial shareholders or directors.
  3. What happens if the business never incorporates?
    If the corporation is not formed, parties to the incorporation agreement may still be held personally liable for obligations made in its name.
  4. Can an incorporation agreement be changed later?
    Yes, incorporation agreements can often be amended by unanimous or majority consent of the parties, though terms vary by jurisdiction and the agreement’s language.
  5. How does an incorporation agreement differ from bylaws?
    The incorporation agreement governs the commitments of promoters and early shareholders before incorporation, while bylaws govern the corporation’s operations after it is formally established.

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