There is no question that starting up a business is a costly endeavor. The expenses associated with purchasing machinery, equipment and furniture, entering into a lease agreement or buying real estate, procuring liability insurance, marketing the business, hiring employees and consultants, and other implementation activities can be quite overwhelming. In an effort to curb initial expenditures, business owners are increasingly turning to online service providers to organize their formal entities. While it is quite understandable that start-ups strapped for cash would be lured in by the buzz words “simple,” “cheap,” and “fast,” the use of these online business formation services may not always be appropriate for every business’s needs and may, in fact, lead to additional costs later.

Below is a brief list of some of the most common problems for which clients have sought assistance from the Harbor Law Group after utilizing the services of online business formation providers:

• The entity structure selected resulted in the company having higher tax liability than anticipated or difficulty with taking on investors. When a business owner secures legal counsel to assist with entity formation, the attorney not only clearly outlines the differences between the various entity structures (e.g. sole proprietorships, partnerships, limited liability companies, and corporations), but also takes into consideration the business’s current and future plans. A business attorney also often works with the client’s accountant to ensure the entity type aligns with the desired tax treatment. Online business formation services, on the other hand, usually request the users of their website to fill in basic information on an electronic form. Because some of the questions posed require background knowledge of corporate law in a business owner’s specific state, many of the answers are filled in incorrectly and thus, the entity is formed incorrectly. Corrective action, which may include amending a filing, dissolving a company and forming a new one, or converting a limited liability company to a corporation or vice versa, can be expensive from both an accounting and legal perspective.
• The corporation does not have enough authorized shares. Many corporations formed by online business formation services tend to have too few authorized shares – and sometimes only 1 share! In Massachusetts, a corporation may be organized with between 1 and 275,000 authorized shares for the same fee. However, if too few shares were authorized by a company’s Articles of Organization and the company now wants to sell or grant equity interests, the company must now pay an additional fee to increase the shares via amending the Articles. In addition to procuring the correct number of shares from the start, a business attorney is also able to assist companies with creating capitalization tables and with determining if there is a need to institute different classes of shares.
• The business name infringes upon another company’s trademark rights. Prior to filing the entity organizational documents, most attorneys perform a thorough conflict check of the proposed business name on local, state and federal levels. However, online business formation services tend to only check the proposed name of the company against other entities registered in that business’s particular state. After spending a considerable sum on website design, signs, advertisements, and marketing materials, a new business owner certainly does not want to risk the additional expense of defending a trademark action.
• Corporate governance documents are incomplete or missing. In addition to handling the transactional aspects of setting up a business entity, an attorney also educates the business owner about, and assists him with, the company’s observance of corporate formalities, such as holding organizational and annual meetings, maintaining a corporate books and filing annual reports. A business attorney may also draft agreements relating to the current operations of the company as well as the operations of the company upon the occurrence of certain triggering events. When online service providers do provide any such services, they are usually limited in scope, may not comport with the nature of the business of the company or the laws of the state of formation of the company, and are quite pricey relative to the quality of the work produced.

As with many other Internet-based services, just because a business is able to be formed online without the assistance of an attorney, accountant or other professional, does not mean it should be. Please bear in mind that most online business formation service providers feature disclaimers on their websites stating to the effect that they are not a law firm or a substitute for an attorney or law firm and therefore, cannot provide any kind of advice or explanations about possible legal rights and options. Therefore, it is prudent to seek the services of a competent corporate attorney when forming your business entity.