Why Your Startup Needs Bylaws

To help your startup succeed with as few internal complications as possible, founders should make having a set of robust corporate Bylaws a priority from the beginning. In this post, we take a look at what Bylaws are, what they do, and why your startup needs to have them in place (hint: it’s the law in Arizona).

What are Bylaws?

While it’s tempting to believe that corporate Bylaws are only for large, faceless, mega-corporations, as opposed to your lean, development-stage startup, nothing could be further from the truth. Any company (of whatever size) that chooses the corporate form through which to conduct its business should really have a well-crafted set of Bylaws in place.

In a nutshell, a corporation’s Bylaws are the internal guidelines that deal with how your corporation will be directed and managed. Bylaws, once adopted by your board of directors, are legally binding terms that establish your startup’s principles, decision making framework, and rules and procedures for shareholder and director actions, among other critical topics.

It is important to understand that a corporation’s Bylaws are not the same thing as its articles of incorporation or charter. The articles of incorporation tend to be very basic and short in length (in Arizona, they can even be generated online via the Corporation Commission website) and includes basic information like the name of the corporation, date of incorporation, the number and type of capital stock of the company, names of the initial directors of the corporation, etc., etc.

Arizona is one of the states that actually requires corporations to have a set of Bylaws in place, at least initially. As Arizona Revised Statutes §10-206 states, “[t]he board of directors of a corporation shall adopt initial bylaws for the corporation.” However, because Bylaws are not required to be filed with Arizona Corporation Commission, as is the case with articles of incorporation, it is possible to incorporate without having Bylaws ready to be adopted. It is something I see far more often than I’d like, and it is definitely NOT something I recommend.

What are Bylaws for?

One of the reasons that technology startups are attractive to many founders (and their investors) is the potential for explosive growth. The problem is, not every founder or co-founder is an experienced business professional (or perhaps worse, thinks they are an experienced business professional). For this reason, the importance of having very clear guidelines and procedures for internal governance of the company cannot be understated.

While founder friendships or somewhat mutually-aligned interests may be enough to keep a lid on internal disputes at your startup at the development or seed stages, significant conflicts can and do arise when millions or even billions of dollars are potentially at stake. It’s just human nature.

Drafting and adopting a strong set of Bylaws is one of the more critical initial tasks of your board of directors.

Bylaws can address how and when shareholder and director meetings are to take place, how they are carried out and recorded, and establish alternatives to being able to take action without actual meetings of shareholders and/or directors.

Bylaws can let you and your co-founders know what the pre-arranged plan is when a co-founder wants to leave, dies, is incapacitated, files for bankruptcy, etc. (though this might be handled in a shareholder agreement among co-founders).

As your startup takes off, it will be necessary to produce copies of your corporate Bylaws to outside investors as part of capital raises or, as was the case I was called in to assist with earlier this month, to obtain commercial loans and lines of credit for your business. It’s far better to have these things in place to provide investors or lenders up front, rather than scrambling to come up with them the under pressure of closing a financing round or loan.

Lastly, Bylaws can be an important “corporate formality” that helps show clear separation between the company and you as its founder personally. This becomes important if (more like when) your company is ever sued. If the plaintiff seeks to “pierce” your corporate veil, and you are unable to show that you observed all of the normal corporate formalities before whatever incident lead to the liability, you are potentially placing your personal assets (e.g., accounts, vehicles, real estate, etc.) at risk, which would defeat a major reason for incorporating as a limited liability entity to begin with.

What should be included in my startup’s Bylaws?

Now that I’ve talked about the importance of the corporate Bylaws, what are some key topics that should be addressed in your startup’s Bylaws?Some of the more common issues I make sure to cover when I draft them for startup clients include the following (again, this is only a very partial, incomplete list!):

  • Corporate name, address, and purpose
  • Ownership classes and rights of shareholders
  • Composition of the board of directors
  • The circumstances and process by which corporate officers and directors can be removed
  • Establishment of corporate officer positions and their descriptions
  • Frequency, location, attendance and quorum requirements for board meetings

The Takeaway

Incorporation is one of the major steps involved in the launch of your technology startup. However, just incorporating without having a well thought-out and properly crafted set of Bylaws appropriate to your company and founder composition could be setting you up for failure or, at a minimum, lots of (potentially costly) headaches down the road or at the worst possible time.

Individuals who are considering incorporating (or who have recently incorporated) their startup should consider retain legal counsel as soon as possible to discuss this all too often misunderstood and ignored aspect of the incorporation process. In many instances, the advice of an experienced attorney can help avoid significant or costly issues related to corporate governance before they arise. To schedule a consultation with our Phoenix startup law firm, call our office today at (602) 222-5542 or send us an e-mail through the online contact form to the right.

Ben Bhandhusavee is the Managing Attorney for BHANDLAW, PLLC, a Phoenix business and technology law firm working with start-up companies, creative intellectual property, Internet and digital media matters, and complex corporate M&A and technology transactions.  Ben can be reached at (602) 222-5542 or by e-mail at bbhand@bhandlaw.com