The Legal Aspects of Establishing and Running a Corporation with David M. Walker, Esq.

Transcription: 

Dayna Thomas, Esq.:
For those of you just starting out in entrepreneurship, you’ll have to decide what business entity structure is best for you. If you watch this show, you know that I’m a huge fan of choosing an LLC for most businesses. But when does a corporation, or C Corp for short, apply?

Although most people associate C corps with big businesses, small startups can also be corporations if it’s the right fit. Here to talk, all things C corp is David Walker, Esq. David is the managing partner at Law Offices of David M. Walker Esquire LLC, serving businesses in Georgia and Michigan. As legal counsel for several multimillion-dollar corporations, David is a pro at advising corporations from initial formation to SEC compliance for publicly traded companies. Now, whether you’re looking to go public or start something smaller, David has the expertise to help.

Now, although we focus on LLCs a lot on this show, today, David will talk to us about the legal aspects of establishing and running a C corp. David, thank you so much for being here.

David Walker, Esq.:
Thank you for having me.

Dayna Thomas, Esq.:
We have known each other for some time. When I first started out, I come to you occasionally for some advice.

David Walker, Esq.:
That’s right.

Dayna Thomas, Esq.:
And definitely refer my corporation clients to you because that is your specialty and the LLC is mine, even though you work with both. Before we jump into the corporations aspect, tell us about you and your background and leading up to where we are now.

David Walker, Esq.:
Sure. I’ve been doing corporate law for 24 years. I started off at big law firms. I was president of a venture capital firm. I was corporate council to a venture capital firm. Took a couple companies public. One was a Korean nano tech company here in the US. I’ve taken a US company in public in Germany.

Dayna Thomas, Esq.:
I read that.

David Walker, Esq.:
And then I was corporate council for a public company. I really left all that in ’08 to work exclusively with startup and small businesses here in Atlanta, and that’s really where I like to concentrate. I don’t do any bad news law like divorce, criminal, DUI, bankruptcy.

Dayna Thomas, Esq.:
None of that. We’re building.

David Walker, Esq.:
Yes. Good news only. I’m a good news business attorney, and I love working with these entrepreneurs and helping them through these sort of startup decisions. It helps when the back end of it and they have confidence in some of the recommendations.

Dayna Thomas, Esq.:
Right. I love that you call it a good news business attorney because I feel that way. I don’t want to be so combative. I want to work with people who are looking to build something, help people accomplish their dreams, all that good stuff. In terms of corporations, we’re going to go to the basics. What is a corporation or C corp?

David Walker, Esq.:
Okay. I think the basics actually starts with America, right?

Dayna Thomas, Esq.:
Wow!

David Walker, Esq.:
Yeah, let’s go way back how we started America. The corporation historically has been the vehicle to create business liability protection. In general, America’s very capitalistic, entrepreneurship driven, so they want to encourage people to get into business. The first thing that scares people is being sued.

Dayna Thomas, Esq.:
Right, liability.

David Walker, Esq.:
Liability. The corporation was the first thing created to kind of keep the liability protection. The corporation can pretty much do everything a person can do except for vote, right? Arguably you can’t vote.

Dayna Thomas, Esq.:
That’s a good way to put it.

David Walker, Esq.:
In order to get this standing, the state asks the same things that they might ask a person. You need a social security number, birth certificate. Same thing with an LLC, they want to kind of know who you are, who can I contact if I need to get in contact with you, tell us a little bit about your business. And then the IRS, like your social security number, wants to know, okay, what is this entity doing and how should we tax it? A lot of entrepreneurs are really making those first two decisions when they form their company. What should I tell the secretary of state of Georgia? What entity should I be to have a protection? And then what should I tell the IRS for how I want to be taxed?

The formation of the LLC was pretty much the idea that, hey, we’ll give you this protection at the state level, but you have to comply with certain things in order to keep this protection. Not just the annual fee, right? But there’s other things we’re going to require of you to keep this protection. And then the IRS says, “Okay, we’re going to tax the money that that company makes.” That’s the premise, right, is you tell the secretary of state who you are. They give you protection. Then you tell the IRS you’re forming a corporation. They say, “We’re going to tax it.”

The intricacy comes with the secretary of state and how you actually operate your business right in compliance with them, because the operation of your business in a corporation, although you don’t have to record it with the secretary of state, is still required. A lot of times people think, “Well, if I just form a corporation and pay the fee, that’s all I have to do to have that protection.” And it’s not. There’s a governance and it’s governance you don’t have to turn in. Imagine somebody giving you a bunch of homework…

Dayna Thomas, Esq.:
You have to monitor yourself.

David Walker, Esq.:
Yeah. Some teacher giving you a whole bunch of homework that you have to do, but you never get a grade. Same thing this, except when somebody asks for your diploma. In our case, when you get sued. The idea is that the managers of the corporation and the owners of the corporation have specific names different than the LLC, shareholder versus member, directors and officers and the corporations versus managers. But those directors and officers historically have been the ones that manages the company, and then you have shareholders, but each level requires a lot of corporate governance.

Dayna Thomas, Esq.:
Absolutely.

David Walker, Esq.:
What happened is it’s kind of a disincentive if you’re one person, right?

Dayna Thomas, Esq.:
Yes, it is, which is why we’re talking about it today what the difference is. I love how you mentioned the similarities between being a person and a company, because it really is just like another person. That’s how I explain this to my clients. You’re saying the Articles of Incorporation is the birth certificate.

David Walker, Esq.:
Correct.

Dayna Thomas, Esq.:
The EIN is the social security number.

David Walker, Esq.:
That’s exactly right.

Dayna Thomas, Esq.:
I love that, and the other analogy you made about homework. I’ve never heard it that way, but that makes perfect sense because that’s the thing or the reason why I don’t normally recommend corporations for single member entrepreneurs that are just starting out, unless it really fits in specific situations because it is like giving them homework.

David Walker, Esq.:
Yes.

Dayna Thomas, Esq.:
Hard homework that will never get checked, that you have to do all the time and make sure that you’re getting at least an A, right? A minus on it maybe. But I love putting it like that. Along with that, I want to make it clear to viewers about the difference between S corp and C corp, because people often say, “Can you form an S corp for me,” and I have to explain to them that you don’t form it. So please elaborate.

David Walker, Esq.:
Great. Just like the secretary of state provides two choices for your liability protection, the LLC and the corporation, the IRS really gives you a menu of options to choose. They have things… The title of the options are confusing because they sound a lot like the entity choices at the state level. Their titles are S corp and C corp and partnership and sole proprietor and disregarded entity. These are terms that sound like, oh, I’m not a sole proprietor, so I don’t want to be taxed as a sole proprietor, but it would’ve been easier if the IRS said tax categories A, B, C, D E. So everyone would say, “I’m a LLC, tax is category C, or I’m a corporation, tax is category B.”

But that’s not the case. The labels of the menus are based upon tax codes. S corp and C corp are based upon sections of the tax code. That’s where people get this from. The truth is the IRS allows you to choose S corporation tax status, C corporation tax status, and other tax statuses depending on what your entity is. When you form a corporation, the default they give you is C corporation taxation. That means the corporation pays a tax. At any time the shareholders get a distribution, they pay a tax. That’s where the double tax comes from. That’s bad for a startup business owner.

Dayna Thomas, Esq.:
That’s right. You’re paying more in taxes.

David Walker, Esq.:
Because a lot of times they need to get that money out, and they pay a tax and double tax. The S corp though says, “Hey, we’re not going to tax the corporation. We’ll just tax you when you take it out.” A lot of times that’s the reason why being taxed as an S corp is beneficial, but you can be an LLC taxed as an S corp. Now, how do you choose S corp tax selection? That’s not for me.

Dayna Thomas, Esq.:
I always say that too. This is the basics, but talk to your accountant.

David Walker, Esq.:
Yes, about whether you should be a C corp or S corp when you form a corporation because it matters. There are some cases in which a small business might still want to be a corporation formed as a C corp. I know that they’re not only going to pay themselves a salary and not take any money out as a shareholder, they might want to do that. Some people don’t want to deal with the tax returns that comes with the S corp or pass-through. They want to be a C corp because it’s an easier tax filing.

We’ll get into that when we talk about investors and why you might choose the C corp taxation. But having that discussion with your attorney, as well as with your accountant is very important early on to make sure the tax category is right for you.

Dayna Thomas, Esq.:
Absolutely. I just want to elaborate on the S corp versus C corp, LLC thing, because that is a common question. Someone will come and say, “Hey, I want to form an S corp.” They have no entity structure and their question is or their desire is, “I want to form an S corp.” An S corp is not a business entity structure that you file with the secretary of state. You can choose a corporation, or you can choose an LLC. An S corp is a way that you can be taxed. You can elect to be taxed as an S corp through the IRS. That means that as a corporation, you can be taxed as an S corp, or even as an LLC you can be taxed as an S corp, but you do not form an S corp as your business entity structure. Right, David?

David Walker, Esq.:
That’s exactly right. Two different choices, two different decisions independently of one another.

Dayna Thomas, Esq.:
All right. We have debunked that myth. Types of businesses that should be or you would recommend to be a corporation. I remember when I was a baby lawyer and I asked you this question, when should a company ever be a corporation, and you gave me very small situations. Can you tell me more about that?

David Walker, Esq.:
Well, yeah, I think it’s important to understand too why the LLC was formed in the first place.

Dayna Thomas, Esq.:
Let’s talk about it.

David Walker, Esq.:
The LLC was formed in the early ’90s because they wanted people to have an easier way to get into business. LLC, you form it. Pretty much as a single member in most states, if you just pay your annual fee, they’re going to give you that protection without the homework. That’s what people wanted is like the protection without the homework. And that became very popular with the LLC, so everyone started a business, started running out to do this. But it’s still a very new entity from the corporate law perspective of America. There are certain industries, government contracting and government, that really aren’t used to still seeing an LLC document.

They still want to see you have a corporation. A lot of times when people want to transfer their money out of their savings account for their business, so maybe you have a IRA or some other security you can access, then a lot of times, if you talk to them about putting investment in your company, they will require a corporate structure. There are some scenarios in your industry that might require a corporate structure, even if you prefer to be an LLC. But again, those are far and few between. I think I maybe form maybe less than a half dozen corporations per year were probably over 500 LLCs.

Dayna Thomas, Esq.:
Exactly. Yes.

David Walker, Esq.:
I mean, the ratio is still very narrow. Sometimes too when… The reason I don’t form corporations is because a lot of times they start off as LLCs. However, later in life, as you mature, you will get into a corporation. Everyone who’s scared of being a corporation or a C corp, it actually is going to get good as we talk about later in publicly traded companies, et cetera. But for the beginning startup person, most of the time it’ll be a LLC.

Dayna Thomas, Esq.:
Yep, and you can convert to a corporation as well.

David Walker, Esq.:
Yes, you can also convert. Some people sometimes get nervous about a corporation and want to convert to an LLC. They’ll say, “Oh, Dave, you said corporation have homework and I didn’t do my homework,” and they’ll say, “Can I convert to an LLC?” Again, I think you have to be very careful with that because sometimes, like you said, when you’re converting corporations to a LLC, you can automatically trigger a change in your tax conversion from a S corp to a C corp, et cetera. You have to be very careful about doing that.

Again, sometimes the industry you’re in is not really ready for a change like that, so you might have to reapply sometimes if you change. That all has to be thought through. It shouldn’t be just rashly done. Sometimes people just say, “Hey, let’s just do the homework,” right? Sometimes you say, “Look, I know you haven’t done it, but it’s better to keep you as a corporation for now and let’s do the homework.” It just depends on the scenario.

Dayna Thomas, Esq.:
Essentially when you form a business or a company, the goal is limited liability, right? You want to protect your personal assets. Because in business, you will inevitably have risks, there’s inevitably liability, so you want to reduce that and keep it separate from you as much as possible through a limited liability. You form a company in order to have that other person. Your business is that other person separate from you. Now, when you have a corporation, there’s a lot of homework, as we’re talking about, that you have to do. If you don’t do your homework, then it jeopardizes that liability protection.

If you ever get sued, have a financial liability, or a defendant in a lawsuit, then they’re going to ask for your homework, as David just mentioned. If you don’t have your homework, your minutes, different documents that are required for your corporation, then what’s going to happen is they’re going to do something called pierce the corporate veil, which is they are breaking down that liability protection and they’re now suing you instead of suing your company.

Now, when they sue you, they have access to your personal assets, like your house, potentially your car, money in your bank account, all those things that should have been safe by protecting your limited liability, which is why many times I recommend a LLC for many businesses, which is why David said he forms many more LLCs than corporations is because with LLCs, there’s not so much homework like that so that you’re not at risk of piercing the corporate veil so easily. Was that a good summary?

David Walker, Esq.:
That’s excellent summary. Excellent summary, but I wanted to shell some good light on the corporate. Let’s talk about the background, the fun part. Everyone scared. They’re like, “Oh my God, I’m never going to do a corporation.”

Dayna Thomas, Esq.:
Which is why I brought you here because I’m semi anti-corporation, just honestly.

David Walker, Esq.:
No, no, there’s some good value.

Dayna Thomas, Esq.:
I wanted to bring you here to show the other side, so please. I love this.

David Walker, Esq.:
I think when you talk about the value of corporation, you really have to start with the state of Delaware. We talked about America. We talked about the corporation being the foundation. Well, the corporate lawyers selected Delaware as the place in which they can trust and have a system and the court of laws that just deals with corporation. They deal with piercing the corporate veil issues. They have a very long case law centered around that. A lot of people will hear about the Delaware corporation. If you are a big corporation, then you do want to be in Delaware because Delaware has so many corporate laws to deal with your thousands of millions of shareholders and issues in class action suits, et cetera.

Delaware is very business, very focused on that, versus a town South Georgia maybe gets two or three business deals a year. Businesses prefer Delaware in general. The corporation in Delaware is very popular because of its protections that it gives as your company gets bigger. As you get bigger, you don’t have the issue of double taxation as much is because you’re taking in millions of dollars. You’re paying out employees and you’re doing dividends once a year. You don’t mind being a corporation. And in fact, it gives you better structure. You don’t have to have an operating agreement for a million shareholders. Now you just say, “Hey, here’s our bylaws. Here’s how we operate,” and you hold your meetings.

Everyone’s goal is to get into Delaware one day. You might see people forming even LLCs in Delaware. With a corporation, Delaware is the standard. These public companies, a lot of times they all started off in their individual states as something else, as a Georgia LLC, et cetera. You can then merge your LLC into a Delaware corp. In fact, Delaware has made it very easy to do that, to take whatever entity and state you’re in and just move it into a Delaware corporation.

Dayna Thomas, Esq.:
When you say merge it, are you talking about form a separate company…

David Walker, Esq.:
No. It’s the same company.

Dayna Thomas, Esq.:
Just transfer it to Delaware.

David Walker, Esq.:
Yes. Instead of being a Georgia LLC, you’re now a Delaware corporation, and then you would actually have to apply as a foreign entity in Georgia. I hope that wasn’t too much.

Dayna Thomas, Esq.:
Nope. Nope. We love it. Please.

David Walker, Esq.:
Delaware corporation, what’s the big deal? I think a lot of those corporations are publicly traded. When you go through fundraising, let’s go back to the scenario of the single member LLC. If I’m a single member LLC and I want to bring on an investor and supposed the investor is in Texas or in New York. I make them a 20% partner, and that they pay me to invest and they become a 20% partner. Well, the IRS is going to say, “Hey, this partner has to pay taxes.” Well, you’re now a LLC and the LLC is not taxed, just like the S corp is not taxed.

The LLC is not taxed, and so now you’re taxed individually and the partner is taxed individually. Now, depending on how your business does, this New York partner has to file taxes.

Dayna Thomas, Esq.:
The Texas one.

David Walker, Esq.:
I mean, Texas one. New York has to file in your state and has to file a tax return because you now told the IRS they’re a member. That investor doesn’t want you to be a pass-through entity or a S corp. They want you to be a C corp taxation, because investors don’t want to have to deal with taxes. You say to investor, “How am I going to get my money out then?” And they go, “You’re going to have to work for the company as an employee and we’ll pay you a salary, but we’re not going to have this pass-through situation because I don’t have to deal with the taxes every year.” You definitely become a corporation or C corp taxation at that time when you have investors.

Now, could a LLC change from like a S corp to a C corp taxation? Sure. They could. But by the time you do all that, you better just move into a corporation and then become C corp taxation, which is expensive. I don’t want people thinking like, “I could go do that on LegalZoom.” It’s expensive, but that’s a good thing because you have enough money to pay lawyers for that to happen. When people come out as a startup though and say, “I want to be a Delaware corp,” I’m like, “Oh my gosh, you’re going to spend a lot of money for a company that doesn’t need to.”

I tell them, you just have to get into business and grow and we can make you that later, because Delaware also has a lot of franchise taxes and fees that you have to… It’s expensive.

Dayna Thomas, Esq.:
It’s for more successful businesses that have longevity.

David Walker, Esq.:
It’s the Ferrari of businesses and you don’t need a Ferrari yet.

Dayna Thomas, Esq.:
Exactly. We’re just starting out.

David Walker, Esq.:
Yes. Yes.

Dayna Thomas, Esq.:
I think that’s a good point. That was the next point that I was going to get to because people often think, “Well, I saw it online that I should form my company in Delaware.” Maybe at a later date. But as a startup company, would you agree that it’s not necessary?

David Walker, Esq.:
No, it’s not. It’s not. There are some startup tech companies that, Silicon Valley, they’re going to take off right away so they go right to Delaware. If you have a high top tier law firm and you don’t mind paying those kind retainers, they will form you in Delaware. It’s about your startup capital and really going to approach. If you know you’re going into an investor market right away, accredited investors, and you’re going to have to be there, yes, go right to Delaware, form a Delaware LLC, or a corporation in Delaware and go there. But most people, I said, unless you’re going to raise capital soon, let’s just…

But I tell them, “We can get there. Don’t think that I’m trying to crush your dreams. We’re going to get there, but I’m trying to manage the expectation and know that we’ll flip the switch when it’s time.”

Dayna Thomas, Esq.:
Exactly. There’s a time for everything and do less homework in the beginning. And then later on, you can do more when you graduate.

David Walker, Esq.:
That’s right.

Dayna Thomas, Esq.:
We went from corporation 101 to 102 to 103, which is great, the progression. I think it’s very obvious to the viewers and everyone who’s watching that they are going to need an attorney to help them with all of this. Tell us about an attorney’s role in assisting with corporations.

David Walker, Esq.:
Yes. We talked about the formation process and helping you form the documents, but also into advising you not just on the corporate documents, like the shareholder minutes or the officer and director minutes, but also sort of what do you want to include with your shareholder rights. You have what’s called a shareholder agreement. In LLC, this is all easy. One document, everything, who’s running it, who’s getting what.

Dayna Thomas, Esq.:
It’s called your operating agreement.

David Walker, Esq.:
Yes. In the corporation, each of those actions are in different parts of different documents. Your bylaws, for example, will govern your meeting times of your shareholders and your officers, right? And then you’d have your articles kind of govern the constitution of the company. And then you have individual shareholder agreements. And then you obviously have different classes of stock you’ll have to create. You have one stock that might be voting, non-voting. And in your shareholder agreement, you might have certain voting rights like, hey, certain employees I have to approve.

All these little details of how you manage a company that you see in the operating agreement, you have to go through a corporation and put in the right areas. You can’t just make a blanket document. You say, “Hey, if I wanted make sure that five out of the seven board directors have to approve this, where do I put it?” In the shareholder agreement, no. In the articles? No. In the bylaws? Yes. You got to figure out where to put the documents, and that’s hard. That’s difficult a lot of times for startup companies to try to figure out where those things should go.

Dayna Thomas, Esq.:
With the attorney, you bring it to that attorney. “Hey, these are our goals. This is where we’re trying to do. I want to change this. Are we bringing in someone or changing something?” The attorney really should be like the right hand person of the company because there’s a lot of decisions that are being made. As we discussed throughout this whole episode, you really should be doing it correctly to protect that limited liability. One more thing I want to talk about, Positivity Water. David also has a water company, an amazing water company. You may have already seen it before as well, but I’m excited for you to share. Tell us about your water company.

David Walker, Esq.:
Sure. I started a bottled water bottling and distribution company by the name of StarWalker Industries about six or seven years ago. We’re building closed loop circular bottled water plants for small communities where you can distribute bottled water locally and bring the plastic back with an incentivized return. In this case, our bottles are 20 cents to return. We’re creating this circular system. But along the way, I’ve gotten into distribution of brands and we have a brand called Integrity Spring and Purified. This is our Positivity Alkaline Water brand. 9.5 pH. People who are into health, fitness, or battling illnesses, they’re looking for an alkaline diet and they prefer alkaline water as their drink.

This is the good tasting alkaline water. Positivity on the belt line, down on university in 75. It’s growing really fast. The local community has really adapted to it. Our bottle return too is starting to get along. We collect the bottles when people return them. Most people donate the 20 cents to a local charity, a Village United that puts on a lot of entrepreneurship programs. And then we take this what we call super sack and we ship it up to Rome and it goes right back into the plastic industry, because this is very valuable. We see our bag of PT1 bottles and people don’t know that, that bottled waters are valuable together.

But when we separate them or put them in the blue bin with other recyclables, they can never become a bottled water again. They can become a park bench. They’ll never become bottled water, but these bottles can actually become bottled water again.

Dayna Thomas, Esq.:
That is amazing.

David Walker, Esq.:
It’s a fun process, fun staff. It’s a fun venture and think positive. Drink Positivity.

Dayna Thomas, Esq.:
Absolutely, and that sounds great too. I’m drinking Positivity. I need some Positivity today. Let me drink some Positivity. Thank you for bringing some and I appreciate the case that you’re going to send.

David Walker, Esq.:
Yes, yes, no problem. It’s on its way. We’re the Chick-fil-A of bottled water.

Dayna Thomas, Esq.:
Oh, love it!

David Walker, Esq.:
We make sure everybody gets taken care of.

Dayna Thomas, Esq.:
Thank you so much, David, for being here, for sharing about corporations. I’m like the LLC champ. You’re the corp champ. But we can always come together to bring some information and education to entrepreneurs.

David Walker, Esq.:
Thank you for having me. This has been awesome. You’re doing very good for the entrepreneurial community. I appreciate your work.

Dayna Thomas, Esq.:
Well, I hope today’s show help to educate and inspire you as you pursue your business goals. Be sure to share today’s show with someone who can benefit and visit MyASBN.com and subscribe. If you have any questions or comments about today’s show, I would love to hear from you, send me a message or comment on Instagram at @daynathomaslaw. Remember to tune in next week and every week to make sure your business is launched and legal.