Drafting and use of preincorporation agreements

April 21, 2015

Report reviewPreincorporation agreements include various contracts entered into by incorporators, promoters, subscribers and the principals (e.g., executive officers and directors) regarding the future organization of a corporation. The agreements establish the ground rules for the organization, capitalization, and management of the proposed corporation. Other agreements may also be used in certain instances, either separately or in combination with the general preincorporation agreement. For example, reorganization of an existing business that had been operated in the partnership form into a corporation may require special provisions, particularly if the new corporation has not elected to be treated as a “pass-through” entity for tax purposes (i.e., a Subchapter S election). Also, those parties who will be working with and for the corporation may wish to enter into employment agreements which will become effective on completion of the formation and organization of the new corporation.

In order for the process of preparing the necessary preincorporation agreements to proceed smoothly, the attorney should be sure that the clients are familiar with the steps that will need to be taken in order to form the corporation and the specific issues that they need to consider in order for the agreements to fit their particular circumstances. Much of the information can be exchanged at face-to-face meetings between the attorney and the clients; however, attorneys should also send letters to the clients that describe the procedures for forming new business entities (see Specialty Form at § 29:100) and summarize the form and content of owners’ agreements-shareholders’ agreement in the case of a corporation (see Specialty Form at § 29:101). If it is more convenient, the attorney may also use a standardized e-mail message that template that includes a list of all the information that the attorney will need from the client in order to form a new corporation (see Specialty Form at § 29:102). Once the information has been collected, the attorney should circulate drafts of the proposed forms of key documents and, if appropriate, convene a preliminary meeting of the organizers of the new corporation to approve the articles or certification of incorporation which are to be filed and any other relevant matters. Minutes of any such preliminary meeting of the organizers should be prepared (see Specialty Form at § 29:94) and included in the minute book for the new corporation.

An agreement to incorporate may be used by the parties to establish the general terms and conditions associated with the formation and initial organization of a new corporation. See Master Form at § 29:24. The content of a preincorporation agreement will vary depending upon the circumstances. Among the matters which are commonly included in such an agreement are the following:

  1. Names and addresses of the parties;
  2. The proposed name of the corporation and a description of the procedures that will be followed to check the availability of the name and reserve it for future use on behalf of the corporation;
  3. A description of the proposed purpose and activities of the corporation;
  4. A summary of the place or places where it is anticipated that the corporation will conduct its business, including a statement of the procedures that will be followed in order to qualify the corporation as a foreign corporation;
  5. A description of the proposed capitalization of the corporation, including subscriptions by the parties;
  6. A list of the incorporators, initial directors and officers of the corporation;
  7. A description of the terms of engagement of any persons required to assist in the incorporation process, such as lawyer, accountants or appraisers.

Other matters which might be covered in a preincorporation agreement include the following:

  1. A description of the terms of any proposed employment relationship between the new corporation and any of its organizers and/or promoters;
  2. The general terms of any buy-sell arrangements among the corporation and its future shareholders;
  3. If the principals wish to have the corporation treated as a Subchapter S corporation for tax purposes, the agreement may contain various covenants regarding the steps that will be taken to perfect and maintain Subchapter S status;
  4. A description of any proposed purchase of assets by the new corporation, which will be relevant whenever the new corporation is going to take over the operations of a going concern;
  5. When subscriptions will be sought from persons not otherwise affiliated with the founding group, a description of the procedures that will be followed in making the offering, including the preparation of an offering document, engagement of investment bankers and payment of the fees and expenses associated with complying with any securities law requirements;
  6. If an existing business will be incorporated, a description of the assets that will be transferred to the new corporation, the shares that will be issued in exchange for each proprietor’s interest and a summary of the tax elections that will be made in connection with the incorporation.

Preincorporation agreements can be particularly useful in situations where the principals intend to form a statutory close corporation (§§ 40:1 et seq.). See Specialty Form at § 29:89. In that case, the agreement should specify the name of the corporation; the state of incorporation; the corporate purpose; the capitalization of the corporation; the contributions to be made by each of the proposed shareholders; and details regarding governance of the corporation (e.g., directors and officers).  Similarly, a preincorporation agreement is often used when the principals intend to take advantage of certain tax planning strategies such as forming a Subchapter S corporation that will also be issuing shares intended to qualify for special tax treatment under I.R.C. § 1244. See Specialty Form at § 29:91.

Share transfer restrictions and buy-sell provisions will also be included in many cases. See Specialty Form at § 29:88. In addition, the new corporation may enter into an agreement with each of the founders that describes the terms upon which the founders will provide consulting services to the corporation until it obtains outside funding and also describes the terms of employment for the founder by the corporation once the funding has been completed. See Specialty Form at § 29:99.

Preincorporation agreements which include parties other than the principals may be useful in certain cases. For example, some form of preincorporation agreement is usually appropriate when a bank or other institutional lender is willing to take stock in a new corporation in satisfaction of preexisting claims and agree to make additional advances in the form of loans to finance the new corporation. See Specialty Form at § 29:95. A preincorporation agreement may also include detailed provisions regarding the terms of securities to be issued to outside investors, such as preferred stock and/or convertible subordinated notes. See Specialty Form at § 29:90.

An interesting variation is an agreement entered into prior to formation of a new corporation that sets out the terms upon which one of the parties to the agreement may become a shareholder of the corporation at some point in the future after certain conditions have been satisfied and/or the party has performed activities detailed in the agreement. One example would be an agreement between a construction company and a real estate management company that provides for the construction company to form a new corporation to acquire property and construct a new building on that property and calls for the management company to assume responsibility for managing the building once it is constructed in exchange for shares of the corporation to be issued in the future. See Specialty Form at § 29:92. A related form of agreement would be one between a builder and a rental agent that calls for the builder to erect a new building and the rental agent to find tenants for the building with the equity ownership of the rental agent in the corporation being tied to the agent’s success in locating acceptable tenants. See Specialty Form at § 29:93. A unique feature of each of these types of agreement is that they will not only address issuance of shares and governance of the corporation, but will also detail other aspects of the entire project including the duties and responsibilities of each of the parties with respect to construction, leasing and management of the building that will be owned by the corporation.

Preincorporation agreements may take different forms. For example, the promoter may prepare a proposal for formation of corporation that can be presented to prospective investors and other business partners. The proposal would combine many of the elements of a preincorporation agreement with a description of the proposed business strategy for the corporation. See Specialty Form at § 29:87.  Another scenario would be an agreement between a fundraiser and a founder that contemplates that the fundraiser would eventually receive a substantial minority equity position in the corporation which would be determined by the success of the fundraiser in attracting investors at a favorable valuation for the new business.  See Specialty Form at § 29:87.50.   Additional examples of preincorporation agreements are provided in Shareholders’ Agreements (§ 35:3).