Basic Legal Distinctions

Business Organization

Business abroad can be conducted in many ways. A basic choice is whether to work with third parties or set up one’s own organization. A physical presence in a country can be established by setting up an independent entry or a branch office. The latter is a local extension of the main office. When working with third parties the typical choice is between distributors and agents.

The choice is often made on the basis of all the domestic requirements a business has to fulfill. These include, of course, the legal rules, which are specific to each country.

One of the aspects that matter on the background, even to large multinational corporations, are the different rules that apply to businesses based on their size.

The definition of “small business” is reflected in the size of a country’s market. Broadly speaking in Europe small business is considered to be business with less than 50 employees. In the US that comes close to a mom-and-pop store. There, a small business is generally an independent business with fewer than 500 employees in manufacturing or less than 100 employees in trade. These culturally different definitions also influence legal requirements that are imposed on businesses. One can think of tax and employment regulations, capital or reporting requirements, legal structure, and etcetera.

Business Registration

European companies are usually registered in a trade Register, which is maintained by a local court or Chamber of commerce. Here contact information, names of individuals representing the company, a company’s subscribed capital and other information relating to the company can be found. Typically, a company must file its annual reports and other essential information with the trade register. General terms and conditions are also deposited with the register.

In the U.S. such centralized registries do not exist. Information about the company must be filed and can be found with several agencies, such as state and city tax authorities or the country clerk. The secretary of state of the state in which the company is established is designated for service of process.

This means that if someone wants to sue the company and is not able to find the company’s contact information, she can send her complaint to the secretary of state, who will forward it to the company. Receipt by the secretary of state equals receipt by the company. It is therefore crucial that a company keeps its information current with the secretary of state. Several states have regular filing requirements to that extent.

Foreign companies doing business in a state are required to register when they do business in that state. Many large American cities require separate registration as well. In the US, a business is “domestic” in the state where it was incorporated and “foreign” in any other state. Thus, a Delaware corporation doing business in New York is a foreign business in New York and must register (and become a tax subject) in New York.

Incorporation

In Europe legal entities are established by or through a notary. A notary is an independent, neutral specialized legal professional who fulfills official tasks. He drafts the legally authentic acts involved in the establishing, sales or dissolution of corporate entities. A notary also performs other official functions, notably involving real estate transactions and domestic law issues. In the US these functions are performed by attorneys specialized in e.g real estate law, family law, or wills and trusts.

An American “notary public” is not to be compared with his European namesake. The main authority of a notary public is to legalize signatures, certify copies of documents and administer oaths, all for a very low fee. He is as such not involved in the establishing of a legal entity in the US (although his services may be required when legalizing a signature).

In the US companies can be formed by an attorney, or by anyone else. An entire cottage industry has erupted, purporting to assist self-incorporation with their efforts.

Legal Entities

An array of legal entities is available to anyone who wishes to establish a business. Business can be organized as a sole proprietorship, a partnership, a corporation, or a number of variations thereof. Each has its own advantages and is subject to its own set of rules. Each has its own structure for instance limited liability companies and limited partnerships restrict the personal liability of their shareholders or partners.

The law specifies which formalities must be followed to establish and maintain a corporation or other legal entity though the European and American types of corporate entities appear to be similar there are some substantial differences.

European shears are typically issued at or around their par value. Each type of corporation is subject to a minimum equity capital investment. In many cases that capital must be paid in full at the time of the incorporation. Often the shareholders can opt to invest a certain percentage at the issuance of the stock and remain liable of the remainder.

Usually, that remainder is immediately due upon request of the company.

Where each European country maintains its own distinct laws most US state base their corporation laws on the Model Business Corporations Act. Their rules are not the same but nonetheless comparable. However, Delaware, New York, California and a few other states with a large foreign corporate presence maintain their own systems.

In the US legal entities are not subject to a minimum capital requirement. Theoretically, a corporation can be established with a capital of one dollar. Consequently the par value of American shares is lower: shares with a par value of one cent or even with a zero par value are commonplace. Yet in practice lenders follow strict standards to determine whether a borrower is creditworthy. One of the tools is the use of capitalization ratios. Insufficiently funded companies have limited or no access to loans, credit cards and even vendor credit lines. Moreover, under certain circumstances controlling shareholders can be penalized for liabilities arising from under capitalization.

Self-incorporation Versus Using An Attorney

In the US, a person who wishes to start a corporation is called a “promoter”. American states allow promoters to incorporate a business themselves. It is also possible to hire a third person to arrange the formalities. This does not necessarily have to be a lawyer. Forms, templates and complete incorporation packages can be obtained from specialized companies. These packages are more or less complete and provide more or less sufficient information to get started.

Incorporating a business yourself does not necessarily save money. Depending on the state, attorneys can do a very basic incorporation starting at $ 200 or $ 300. that is not much more than an online incorporation company charges. Additional state fees and charges starting at about $ 1,000 apply. These fees are due regardless of who is doing the incorporation. Thus, for a simple incorporation the costs are about the same.

Where more complex structures are required, the hiring of an attorney is , almost without saying, advised. For instance when a LLC is being established a local attorney, preferably one versed in tax law, may actually be able to bring savings.

In Europe, by contrast, incorporating is a much costlier affair. For instance establishing a B.V. in the Netherlands costs about 5,000 euro, part of which is subject to an additional 19% VAT. This amount either eats into or must be added to the 18,000 euro capital requirement that also exists. In this equation, incorporation in the United State is already a bargain.

The few dollars potentially saved if self-incorporating in the US, versus using the services of an attorney, is further negated by the time that needs to be invested to do the incorporation properly. A major reason for using an attorney is that basic knowledge of state corporation laws is required to avoid problems in the future. The crux of the exercise is namely that the paperwork must be filled out correctly and several documents filed with the relevant authorities.

To correctly draft the minutes of the initial and subsequent Board of Directors and Shareholders meetings the drafter must know which corporate body may make what type of corporate decisions. Blanks in the template articles of incorporation and by-laws must be filled in. they must be consistent with other papers that reflect what decisions were made where and when, and by whom. These documents will follow the company in the years to come and can be reviewed during tax, social security or shareholder audits. Stock certificates and legers have to be completed and other corporate records such as returned certificates of incorporation and filing receipts must be filed. Minutes, consent forms and other corporate documents must be maintained in a timely manner. Whether or not you are familiar with the requirements, they must rigorously followed.

As in many countries, if the paperwork is found not to be in order, a fine may ensure. It can also lead to further scrutiny. Here, that fine will come as a surprise after an audit three to seven years later, likely with penalties and almost certainly with interest. The federal IRS appears to be slightly ore forgiving than state tax authorities, but a few years down the line that may change. Moreover, if the company or parts thereof are ever sold, any incomplete paperwork must be corrected, for instance by an attorney at say $ 500 per hour, meanwhile delaying the transaction.

Additional reasons to not squabble on attorney fees are of an economic nature. First, when requesting outside financing such as bank loans or credit cards, American financial institutions do demand copies of some of these documents, both to see how serious the company is organized and managed and to determine whom they can eventually hold liable. If the papers are incomplete or incorrect, borrowing money can be difficult.

Second, to become a preferred vendor with large buyers, submitting some of these corporate document is part of the standard request by most American purchasing departments. if the prospective client finds that the paperwork is wanting he may decline to conduct business with the company. Here saving a few dollars at the time of incorporation may well turn out to be one of the most expensive mistake a business can make.