Startup Articles of Incorporation and Corporate Governance Structure: Provisions to Revisit When Raising Capital and How They Divide Roles with the Shareholders' Agreement

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

The draft Series A investment agreement contains a clause requiring "approval of the board of directors," yet the company has no board of directors. When moving from the seed stage to the next stage, a company should check for mismatches like this. In such a case, the company has to decide whether to establish a new corporate body or to revise the draft agreement to fit its current governance structure.

The articles of incorporation and the corporate governance structure are not finished once they are filed with the Legal Affairs Bureau and registered at incorporation; they are rules the company continues to use in its day-to-day operations. They are the fundamental rules of corporate management, setting out who decides what, at what stage investors become involved, and how the minutes and records of those decisions are kept. Establishing complex corporate bodies that do not match the company's stage of growth, or oversimplifying while leaving decision-making authority unclear, will both create unexpected burdens in daily operations.

Matters Set in the Articles of Incorporation and Matters Left to Subordinate Rules

Article 27 of the Companies Act designates the following as mandatory matters that must be stated in the articles of incorporation: the purpose, the trade name, the location of the head office, the value of the property to be contributed at incorporation or its minimum amount, and the names and addresses of the incorporators. If any of these is missing, or if what is stated violates laws and regulations, the articles as a whole may be invalid.

By contrast, Article 29 of the Companies Act provides that the articles may state or record matters that, under the provisions of the Act, take effect only if provided for in the articles, as well as other matters that do not violate laws and regulations. The former are called relative matters: matters such as restrictions on share transfers and provisions for optional corporate bodies, which are given legal effect only once they are set out in the articles. Record dates are different from these: in addition to setting them in the articles, a company may, under Article 124 of the Companies Act, determine them each time by resolution of the board of directors or the like, giving public notice at least two weeks in advance as a rule. The latter, optional matters, are matters such as the month in which the annual shareholders' meeting is held; leaving them out of the articles does not affect the validity of the articles themselves, but they are included to clarify internal arrangements.

What should be kept in mind in practice is that it is not a good idea simply to put every matter concerning corporate management into the articles. The administrative procedures for handling shares and the specific operating rules of the board of directors are better left to subordinate rules such as share handling regulations and board of directors regulations. Amending the articles requires, as a rule, a special resolution of the shareholders' meeting, and depending on the amendment, a resolution of a class shareholders' meeting or the consent of all shareholders may also be needed. Subordinate rules such as board regulations, on the other hand, can often be amended flexibly by board resolution, and writing detailed practical procedures into the articles means convening a shareholders' meeting for every minor revision. What to state expressly in the articles and what to leave to subordinate rules should be decided based on how often revisions are expected and whose resolution the company wants to require for a change.

Governance Structure of a Non-Public Company and the Decision to Establish a Board of Directors

Article 326, paragraph 1 of the Companies Act requires a stock company to have one or more directors, and under Article 295, paragraph 1 of the Companies Act, the shareholders' meeting is a mandatory body for every stock company. Bodies such as a board of directors and company auditors are, as a rule, established by provisions in the articles, but depending on the type of company, the law may require them (Article 326, paragraph 2 of the Companies Act).

Specifically, under Article 327, paragraph 1 of the Companies Act, a public company, a company with a board of company auditors, a company with an audit and supervisory committee, and a company with a nominating committee, etc. must have a board of directors. Under paragraph 2 of the same Article, a company with a board of directors must, as a rule, also have a company auditor, except for a company with an audit and supervisory committee or a company with a nominating committee, etc. A non-public company is a company that places transfer restrictions on all of the shares it issues. A company that is non-public and is not a large company, because its stated capital and liabilities do not reach the thresholds for a large company, may choose a minimal structure operated only by the shareholders' meeting and directors, with neither a board of directors nor a company auditor.

However, even a non-public company must appoint an accounting auditor if it qualifies as a large company (Article 328, paragraph 2 of the Companies Act), and a company with an accounting auditor must have a company auditor unless it has an audit and supervisory committee or a nominating committee, etc. (Article 327, paragraph 3 of the same Act). The obligation of a company with a board of directors to have a company auditor has an exception for a non-public company that appoints an accounting advisor (proviso to paragraph 2 of the same Article), but this should be considered separately from the obligation to have a company auditor that comes with the obligation to appoint an accounting auditor.

A company without a board of directors may designate a representative director from among its directors through the articles, through mutual election by the directors based on the articles, or by resolution of the shareholders' meeting (Article 349, paragraph 3 of the Companies Act). If no representative director is designated and there are multiple directors, each director represents the company individually (paragraph 2 of the same Article), so in practice it is essential to settle in advance who holds external authority of representation.

In this way, a non-public, non-large startup is free to compare structures such as having only directors, having directors and a company auditor, or establishing a board of directors. Establishing a board of directors requires three or more directors (Article 331, paragraph 5 of the Companies Act), so the company should consider not just whether it can fill the seats but whether the structure allows for substantive discussion and oversight. Even where there are several co-founders or the company raises outside capital, continuing to operate without a board of directors is a perfectly viable option. The key point in practice is to make the approving body under the investment agreement match the bodies the company has actually registered.

The obligation under Article 327, paragraph 1 of the Companies Act to establish a board of directors is limited to certain types of companies, and if a non-public company has not chosen any of those types, no obligation arises under the Companies Act. In a Series A round or the like, investors may ask the company to establish a board of directors or accept a director nominated by them, but this is a contractual request based on the investment agreement or shareholders' agreement, and it is different in nature from an obligation imposed directly by the Companies Act. If the company accepts such a request without being clear about this difference, it may mistake it for a statutory obligation and overlook room to negotiate and adjust the terms with investors.

When deciding whether to establish a board of directors at an investor's request, the company should check the number of directors and the authority of the investor-nominated director. The timing for sending convocation notices and the resolution requirements should also be checked from the standpoint of whether they can actually be run. Once a board of directors is established, under Article 362, paragraph 2 of the Companies Act, decisions on the execution of business, supervision of the execution of duties by directors, and the appointment and removal of representative directors become duties of the board, and the matters that the shareholders' meeting can resolve are limited to those provided for in the Companies Act or the articles (Article 295, paragraph 2 of the Companies Act). This does not mean that every decision on the execution of business must be made by the board; authority should be allocated by distinguishing the matters that cannot be delegated, such as important execution of business. Because the company moves from a structure in which the shareholders' meeting could resolve a wide range of matters to a board-centered structure, operational tasks such as convocation procedures, the conduct of resolutions, and the preparation of minutes arise on a routine basis. The details of these operational tasks are covered in Running Board of Directors Meetings: Convocation, Resolutions, Minutes, and Written Resolutions.

Furthermore, when a director nominated by an investor joins, that director becomes directly involved in decisions on the important execution of business listed in the items of Article 362, paragraph 4 of the Companies Act, such as the disposal of important assets and large borrowings. Establishing a board of directors means switching to governance by a deliberative body, so whether to accept that request should be decided in light of whether the company is prepared to handle the administrative and operational burden that comes with it.

Provisions of the Articles of Incorporation to Revisit When Raising Capital

As financing rounds progress, many startups need to revisit certain provisions of their articles of incorporation.

• Total number of authorized shares (whether it is set with future capital increases in mind)
• Terms of class shares (provisions on preferred shares, such as distribution of residual assets and put options)
• Share transfer restrictions (whether the approving body is the board of directors or the shareholders' meeting)
• Convocation notice period (whether the period in the articles is still sufficient after outside shareholders increase)
• Term of office of officers (whether to extend it to up to 10 years)
• Method of public notice

Of these, extending the term of office of officers is an issue on which judgments tend to differ. Under Article 332, paragraph 2 of the Companies Act, a non-public company (excluding a company with an audit and supervisory committee and a company with a nominating committee, etc.) may extend directors' terms to up to 10 years by providing for it in the articles. A director's term normally runs, as a rule, until the conclusion of the annual shareholders' meeting for the last business year ending within two years after appointment, but a non-public company can extend this framework to up to 10 years. Extending terms to 10 years reduces the frequency of registrations for appointments and reappointments, but the annual shareholders' meeting itself must still be held every year. The term of a company auditor is four years as a rule, and a non-public company can likewise extend it to 10 years by the articles (Article 336 of the Companies Act).

On the other hand, extending terms too far increases the risk of forgetting the reelection date and being fined for failing to register reappointments, and if a director is removed mid-term without justifiable grounds, the company may face a claim for damages based on the remaining term. This point is explained in detail in When Does a Director's Term Expire? Practice for Reappointment Registration, Resignation, and Removal. The more a company expects its management team and shareholder composition to change with fundraising, the more likely disputes over officer turnover are to surface if it casually extends officers' terms to 10 years.

Amendments to the articles are made, as a rule, by a special resolution of the shareholders' meeting (Article 466 and Article 309, paragraph 2, item 11 of the Companies Act). The original articles at incorporation must be signed or name-sealed by the incorporators, or, in the case of electronic articles, carry an electronic signature or the like on the electromagnetic record, and must be certified by a notary (Article 30, paragraph 1 of the Companies Act). By contrast, amendments to the articles after the company has been formed do not require notarial certification; the company proceeds with a shareholders' meeting resolution and, if the change affects registered matters, a change registration.

Differences in Effect among the Articles of Incorporation, the Commercial Registry, and the Shareholders' Agreement

The articles of incorporation, the commercial registry, and the shareholders' agreement are all documents for checking the rules and structure of corporate management, but the legal scope of their effect differs greatly.

The articles of incorporation are an autonomous set of norms that bind internal bodies, including current shareholders and directors. The contents of the articles do not automatically take effect against third parties, and there are limits to how far the company can assert restrictions under the articles in its external dealings, such as against a person seeking to acquire shares or the company's creditors. For example, even if the articles or internal rules restrict the representative director's authority of representation, that restriction cannot be asserted against a third party in good faith who is unaware of it (Article 349, paragraph 5 of the Companies Act).

Registered matters are publicly disclosed through the commercial registry, and when a registered matter changes, the company is obliged to file for registration within two weeks of the date of the change. Fines for failure to register and day-to-day schedule management are touched on in How to Prepare Shareholders' Meeting and Board of Directors Minutes: Statutory Contents and What Registration and DD Look For. Provisions of the articles themselves are valid even if they do not appear in the registry, but matters that the law requires to be registered, such as the total number of authorized shares and the names of officers, cannot, as a rule, be asserted against a third party in good faith until the registration is completed (Article 908, paragraph 1 of the Companies Act). Even after registration, there is an exception under which the matter cannot be asserted against a third party who did not know of the registration for justifiable reasons, so it cannot be said that completing registration fixes legal relationships in every situation.

By contrast, a shareholders' agreement is basically a contract creating obligations that bind only the parties who entered into it. Whether the company itself has joined the agreement as a party is also a point to check. The agreement does not automatically take effect against future shareholders who have not joined it or third parties who acquire shares from existing shareholders. Nor does stating investors' prior consent matters or the company's information-provision obligations in the articles turn them into absolute rights enforceable against the world. Even if an act violates the shareholders' agreement, that does not necessarily invalidate a resolution or act under the Companies Act; contractual liability for damages and organizational effect under the Companies Act are kept clearly separate. If the parties want to make sure their agreement functions, advance preparation matters, such as incorporating it into a provision of the articles, as with transfer restrictions, or including a clause in the agreement that obliges future shareholders to accede to it. Prior consent matters and the obligations of founding shareholders are explained in detail in Key Points in Reviewing a Shareholders' Agreement: Prior Consent Matters, Information Rights, and Obligations of Management Shareholders.

How to Proceed with Amendment Procedures and What to Check in Advance

When proceeding with an amendment to the articles, a company with a board of directors first decides on the proposal to amend the articles at a board meeting and then convenes a shareholders' meeting by sending convocation notices to shareholders. The contents to be stated in the notice, such as the matters that are the purpose of the meeting, should be checked against the statutory requirements, starting with Article 299 of the Companies Act, together with whether voting in writing or electronic voting is adopted and whether reference documents for the shareholders' meeting are required depending on the proposals. How much of the full text or a detailed summary of the proposal to include in the notice should be decided in line with those requirements.

A resolution of the shareholders' meeting amending the articles is a special resolution, which, as a rule, is passed when shareholders holding a majority of the voting rights of shareholders entitled to exercise voting rights are present and two-thirds or more of the voting rights of the shareholders present vote in favor (Article 309, paragraph 2, item 11 of the Companies Act). The articles may lower this quorum to as little as one-third or raise the required majority above two-thirds. Depending on the contents of the amendment, a resolution of a class shareholders' meeting or the consent of all shareholders may also be required in addition to the shareholders' meeting.

An amendment to the articles normally takes effect when the shareholders' meeting resolution is passed, but if the resolution specifies a future effective date or a condition precedent, that provision governs. For matters subject to commercial registration, the company must apply for change registration at the Legal Affairs Bureau with jurisdiction over its head office within two weeks of the date the change takes effect. How to prepare shareholders' meeting minutes, the documents to attach when applying for registration, and the rules on seals can be found in How to Prepare Shareholders' Meeting and Board of Directors Minutes. When amending the articles in connection with fundraising, organizing the schedule for the shareholders' meeting resolution and the registration application as a single sequence together with the procedures for issuing preferred shares and the signing schedule for the shareholders' agreement makes it easier to avoid rework just before closing.

When reviewing your company's articles and current operations, checking the following points will make it easier to grasp the situation.

• Whether the total number of authorized shares provides enough room to cover the number of shares for subscription to be issued in the upcoming round
• Whether share transfer restrictions are provided for, and whether the approving body is set as the board of directors or the shareholders' meeting
• Whether the corporate bodies provided for in the articles (board of directors, company auditor, accounting advisor, etc.) match how decisions are actually made day to day
• Whether you distinguish between the standard two-year term for directors and the standard four-year term for company auditors, and have checked whether the articles extend those terms
• To what extent the articles contain provisions shortening the convocation notice period for shareholders' meetings and board meetings
• Whether the method of public notice set in the articles matches the disclosure procedures actually used

If these checks reveal a mismatch between the wording of the articles and the company's actual practice, or if a corporate body that the investment agreement to be signed assumes does not exist, the company will compare the current articles with the draft agreement and decide concretely which provisions to revise to match which. The scope of our services, including comparing the articles with draft investment agreements, is described in Startup Legal and Fundraising Support.

Frequently asked questions

Must we establish a board of directors once we raise funding?

Under the Companies Act, if a non-public company does not fall under any of the categories of public company, company with a board of company auditors, company with an audit and supervisory committee, or company with a nominating committee, etc., it is not required to establish a board of directors (Article 327, paragraph 1 of the Companies Act). Even if investors ask, in a shareholders' agreement, for a board of directors to be established or for nominated directors to be accepted, that is a contractual request and a separate matter from the obligation to establish one imposed by the Companies Act. Whether to establish one is a matter to decide in light of both the investors' requests and the company's own operating structure.

Does every amendment to the articles of incorporation require notarial certification?

No. Notarial certification is required only for the original articles of incorporation prepared before the company is formed (Article 30, paragraph 1 of the Companies Act). Amendments to the articles after the company is formed are made by a special resolution of the shareholders' meeting (Article 466 and Article 309, paragraph 2, item 11 of the Companies Act), and if the change concerns registered matters, a registration is made after the change.

Are there disadvantages to extending directors' terms to 10 years?

A non-public company (excluding a company with an audit and supervisory committee and a company with a nominating committee, etc.) may extend directors' terms to up to 10 years by its articles of incorporation (Article 332, paragraph 2 of the Companies Act). However, before deciding on an extension, keep in mind that if the expiry of a term goes unnoticed and is left unaddressed, the company may be subject to a non-penal fine for failing to register reappointments, and that if a director is removed mid-term without justifiable grounds, the company may face a claim for damages based on the remaining term.