Navigating the compliance life cycle of a business entity

Sometimes an organization will form a legal business entity (e.g., a subsidiary) to facilitate an acquisition, spin-off, or other purpose. Whatever the intent, it’s helpful to identify and manage the compliance obligations the subsidiary entity faces throughout its business life cycle: launching, maintenance, growth, and if needed, closing.

Compliance tasks can change over time and vary by entity type, business activity, and jurisdiction, so understanding the obligations isn't always straightforward.

In this article, we delve into the significance of navigating the compliance life cycle of a business entity and provide an overview of the four stages of compliance.

Importance of entity compliance and governance

There are many liability, tax, and other advantages to forming a separate legal business entity. But to maintain the rights and privileges of doing business as a statutory entity, the entity must maintain good standing in its formation state and any other state where it does business.

A Certificate of Good Standing indicates that the entity was validly formed and is in good standing. This certificate is often required by investors, lenders, vendors, and others before they do business with the entity. Many states also require a certificate when you need to register to do business in another state (foreign qualification).

A failure to maintain good standing can lead to a status change for the entity, including the state listing it as delinquent, void, suspended, or dissolved on public records.

Good governance should also be a priority. It’s important to comply with the governance provisions of the formation state’s entity law. For example, a corporation must have a board of directors and hold an annual shareholders’ meeting. Minutes of directors’ and shareholders’ meetings must be kept, maintained, and made available for shareholder inspection. Governing documents such as operating agreements, bylaws, or shareholder agreements often also have provisions regarding how to govern the entity that must be followed.

Complying with the laws needed to maintain good standing, and having good governance practices, can help reduce the risk of having a court pierce the corporate veil — an outcome that could result in the parent company being held liable for the subsidiary’s debts and obligations. Piercing can occur when the subsidiary does not seem to have an existence separate from the parent. A subsidiary that has complied with its statutory obligations and has its own governance structure is more likely to be considered as having its own existence, thus reducing the risk of piercing.

Maintaining compliance across the life cycle of the entity

Stage 1: Launching

The first step in creating a legal business entity is choosing the right type of entity. Entities vary based on their tax treatment, management structure, owner’s rights and liabilities, and other characteristics. There are various factors to consider, including the purpose of the business, the need for liability protection, and whether the owners will actively participate in management. 

Another important consideration is where to form the entity. The formation state is the corporate home for that entity, meaning it is subject to that state’s business entity statute (and certain other laws as well) regardless of where the business operates.

An entity is created by filing a formation document (such as Articles of Incorporation or Articles of Organization) with the Secretary of State or similar office. Most companies will also have to obtain business licenses and permits as required by the state and municipalities where the company does business. The types of licenses or permits needed will vary depending on your company’s location, industry, operations, and products and services.

Below are some common steps involved in the formation of a new entity:

• Conduct name availability check
• File name reservation/registration
• Appoint a registered agent
• File Articles of Incorporation/Organization
• File assumed name or DBA certificate
• Apply for business licenses and permits
• Apply for an EIN
• Obtain a state tax ID
• Order corporate records kit
• Publication in a newspaper (if required by state)

Stage 2: Maintain

After creating a corporation, LLC, or other entity, there are several ongoing compliance requirements that must be tracked and met. These generally fall into two categories: external (meaning those not related to the entity’s internal affairs) and internal (meaning those related to the way the entity is managed, the rights or liabilities of owners, and other matters of internal affairs).

The formation state and any state where your subsidiary corporation, LLC or other entity is registered to transact business (has undergone foreign qualification) will impose external requirements on your business entity. The following are some of the requirements:

• File annual report
• File and pay franchise tax
• Renew business licenses
• Renew assumed name or DBA registration

Corporations and LLCs must also comply with internal requirements regarding their governance. A governing statute and/or internal document may impose these requirements. Compliance tasks may include:

• Holding initial and annual meetings
• Adopting and maintaining updated bylaws/operating agreement 
• Issuing stock/shares 
• Recording stock transfers/membership interest transfers
• Maintaining separate and complete records for all subsidiaries

To prove the existence of any entity for business transactions, you may need to obtain the following: 

• Certificate of Good Standing
• Apostille or Certificate of Authentication
• Certified copy of formation documents

Stage 3: Grow

Your organization's growth strategy can lead to unexpected compliance obligations, including:

• Filing foreign qualification/registration
• Appointing a registered agent in a foreign state
• Obtaining business licenses
• Appointing directors and reporting changes

If M&A is in the cards, thorough due diligence must be conducted prior to filing the Articles of Merger and performing post-merger filings and actions.

Many other activities can trigger new compliance actions, some of which will need to be performed within a certain timeframe. For example:

• Company name or address change: This requires you to file Articles of Amendment with the state, notify the IRS, update business licenses and permits, and more.
• Change of entity type: To convert an entity (known as a conversion), several steps must be completed, including obtaining board or member approval, filing Articles of Conversion, and updating business registrations. There are some states where statutory mergers are the only option for changing the type of entity. In those cases, you would first need to form a new entity (and complete all the steps on the launch stage) and then file Articles of Merger.

Stage 4: Close

If your business is not profitable, if its focus changes, or if its purpose has been accomplished, you may consider closing it down and dissolving the entity.

You may also merge the company into another entity, with your company being merged out of existence. Regardless of the situation, there are several steps to be taken, including the following:

• Obtain approval from the board or other governing body
• File Notice of Intent to Dissolve (if required)
• Obtain a tax clearance letter
• File Articles of Dissolution or file Articles of Merger and post-merger documents
• File withdrawal of qualification/registration (in foreign jurisdictions)
• Cancel assumed name or DBA certificate
• Cancel business licenses and permits

Taking the proper steps to dissolve a company is essential to avoid fines, penalties, loss of liability protection, and the risk of business identity theft.

CT Corporation can help

Keep on top of regulatory changes across your business entity life cycle. Our Entity Management Services can handle all your entity management needs. Supported by a team of experts with specialized knowledge and unmatched experience, CT Corporation is a true partner in your success.