Most user groups start off as a loosely formed confederation of like-minded developers who want to build a learning community. Over time, as a user group grows, it may want to start hosting events, an activity that often necessitates the need to enter into agreements for venue space and to solicit funds. When a user group decides to take this next step, the user group can no longer operate as it once did. Rather, it must organize as a legal entity so that it can, among other things, open a bank account. This is the most often-cited reason why user groups organize as a formal business entity.
This article is for two basic classes of people. The first is the group of people that either have a user group or want to form a user group and want to take it to the next level via a business entity. The second is the group of people that are part of a user group that is organized under a formal business entity but aren’t sure how to properly run such an organization.
DISCLAIMER: This and future columns should not be construed as specific legal advice. Although I’m a lawyer, I’m not your lawyer. The column presented here is for informational purposes only. Whenever you’re seeking legal advice, your best course of action is to always seek advice from an experienced attorney licensed in your jurisdiction.
Types of Business Organizations
There are a handful of business organization types that your jurisdiction likely recognizes and these are enumerated below. The most common type of organization for a user group to select is that of a Non-Stock Non-Profit Corporation. The other organization types are listed for informational and differentiation purposes.
- Sole Proprietorship: As the name implies, this is a single individual where the individual registers a fictitious name with his jurisdiction for the purposes of obtaining a Tax ID Number (TIN). Note: sole proprietorships are not distinct business entities like Partnerships, Corporations, and Limited Liability Corporations (LLCs).
- Partnerships: Partnerships are business entities where two or more individuals and/or entities enter into an agreement and register under a given name with their jurisdiction. There are several different types of partnerships including General Partnerships (GP), Limited Partnership (LP), and Limited Liability Partnerships.
- Corporations: Corporation types can be broken down into two main types: profit and non-profit. For a user group, the most applicable type is that of non-profit for the simple reason that the purpose of the organization is not to make a profit to distribute to shareholders. Rather, a user group non-profit is usually organized for an educational mission. Typically, non-profits are organized on a non-stock basis, meaning that unlike a for-profit corporation that is owned by shareholders, a non-profit is typically in the care of and run by a board of directors for the benefit of its members or some other community. Corporations, unlike partnerships and sole proprietorships, are distinct entities unto themselves and stand apart from any individual person.
- Limited Liability Corporations (LLCs): LLCs are a hybrid of the partnership and corporate model. LLCs retain the simplicity of a partnership while maintaining the liability shield of a corporation.
Because a user group is typically organized for non-profit purposes, the only feasible entity is the non-profit corporation structure. Just because there aren’t profits involved, don’t think for a moment that it’s all fun and games. In most jurisdictions, the most heavily regulated and scrutinized businesses are non-profits. The reason is that because most non-profits run correctly under the law, non-profits are often used as part of fraudulent and criminal enterprises. As it turns out, running a non-profit is not that difficult. Like anything, you just need to understand and respect the rules.
Just because there aren’t profits involved, don’t think for a moment that it’s all fun and games.
Creating Your Non-Profit
Creating a corporation is, to many, surprisingly simple. You only need a few things to get started:
- A unique name
- Articles for incorporation, which is a document that sets forth the basic mission of your organization, its name, and address. Depending on your jurisdiction, the articles may also indicate whether your organization has members or not and whether the non-profit is organized on a stock or non-stock basis.
- An initial slate of officers/board members (president, secretary and treasurer, at a minimum)
- The filing fee
You may have heard about a document known as by-laws and may be wondering why I didn’t mention them above. The reason is that in spite of their importance, by-laws are not required to form a non-profit corporation. By-laws set forth the parameters of what the board of directors are allowed to do on behalf of the corporation. By-laws also specify things such as the maximum and minimum number of board members, when and how elections occur, how board vacancies are filled, etc. In the absence of specific by-laws, most jurisdictions codify a number of default rules to govern board of director conduct.
Once you file your paperwork, you now have a corporation and you can then obtain a Tax ID Number (TIN) from the Internal Revenue Service (IRS). Once you have a TIN, you can open a bank account.
Observing Corporate Formalities Isn’t Optional!
One of the things that sets the corporation structure apart from other structures is the need to observe what is collectively known as corporate formalities. This includes regular business meetings where minutes are taken and votes recorded for actions the board takes. In the case of a user group, having a user group meeting may satisfy this requirement.
A good user group meeting is divided into two parts. The first is the business part where a meeting is called to order to discuss the organization’s business. This often includes an approval of minutes from the previous meeting, a financial report, committee reports, etc. The second part of the meeting is where the fun stuff happens and you talk about whatever it is that brought you all together.
It’s important to understand that a corporation is a distinct entity and it must be run as such. Otherwise, the organization ceases to operate as a bona-fide entity and instead becomes an alter ego for one or a few people. This is when there can be a great amount of unintended consequences and legal trouble.
At the very least, a corporate entity must have an annual meeting to, among other things, hold elections for the board and offices such as President, Vice-President, etc. Annual meetings also afford an opportunity to ratify actions taken in the current year, approve budgets, and ensure legal compliance. Well-run non-profits hold business meetings several times a year, whether they are monthly, quarterly, or semi-annually.
Annual Filing Requirements
Depending on what your user group non-profit does and the requirements of your jurisdiction, you may have annual filing requirements to satisfy.
As time goes on, the organization may change and the by-laws may have to change as well. There is a formal process to amend by-laws that is typically stated in the by-laws themselves.
If You’re Not Observing Corporate Formalities, What’s the Big Deal?
If your group is dormant and doesn’t have any activities, most likely, there’s no big deal. In that case, the group should consider formal dissolution procedures. If, on the other hand, yours is an active group that, among other things, solicits, receives, and disburses money, the consequences can be severe.
Remember that a corporation is a distinct entity and that a board of directors acts on behalf of the corporate entity. Let’s assume for a moment that a corporation with members has been in existence for 10 years, but has never held an election nor had any business meetings and that votes were never taken. Assume further that during this time, funds were solicited and spent in the name of the corporation. In such a case, there’s a strong argument to conclude that such funds where fraudulently solicited and spent because there was no authorization to do so. Again, it’s important to stress that a corporation is a distinct entity and that it’s the rules of the entity that confer the authorization to act on its behalf. In this particular case, there are problems with the solicitation of funds and the withdrawal of funds from the organization’s bank account. Depending on your jurisdiction, the amounts involved, and other circumstances, criminal conduct maybe involved that can be graded as a misdemeanor or a felony.
Depending on your jurisdiction, the amounts involved, and other circumstances, criminal conduct may be involved that can be graded as a misdemeanor or a felony.
Director Liability and Avoiding Conflict of Interest
Ultimately, the caretaking and well-being of an organization depends on its board of directors. The idea is that although the board and members come and go, the organization will endure. This is why for non-profits; board members typically serve on a volunteer basis. If there’s any malfeasance on the part of the organization, the directors, both as a group and individually, are on the hook legally.
What is allowed? That depends on what the by-laws state. In the absence of by-laws, what a board and organization is allowed to do is narrowly construed to be just enough to support the mission outlined in the articles of incorporation.
The watershed moment for most groups is when they start dealing with money and further, when they pay out money to individuals. This is where non-profits have to be very careful. As a rule, to undertake such actions, there must be by-laws stating that such actions are permissible. One issue that’s often raised is if a board member can be compensated. As a rule, the answer is a hard and fast no. The only way around that is to have a provision in the by-laws that carves out an exception for directors. If such an exception does not exist, the by-laws can be amended in accordance with the procedures set forth in your organization’s by-laws or your jurisdiction.
If you find yourself in need of forming a business entity for your user group, you need to understand that it won’t be business as usual anymore. There are a number of regulations, for good reason, that govern how non-profits are operated. When dealing with money, extra care must be taken to avoid any actual or appearance of impropriety. As a best practice, have a well defined set of by-laws that clearly outlines the actions the organization and directors are allowed to undertake.
If there’s one word that you’ll want to keep in mind, it’s the word transparency. Always be transparent in your dealings with open meetings. Most importantly, be exceedingly transparent with your finances. At the end of the day, you want your organization to transcend any one person or group of individuals so that although individual leadership changes, the organization will endure.