The Virtual Company

Entrepreneurs have always chafed against the formalities and procedures demanded of them by their attorneys and, more generally, by business laws. Who hasn't had to keep reminding clients of the importance of signing and returning annual minutes ' again and again and again?

This is even more so for the tech sector, and e-commerce founders. After all, they created an industry by thinking outside the proverbial “box,” so why should their creativity be constrained by legal rules created for the age of the steam engine?

From Virtual to Reality

That paradox lies behind the concept of the “virtual company” (see, http://en.wikipedia.org/wiki/Virtual_business#Virtual_corporations, http://virtualcorporation.org, and http://dotank.nyls.edu/VisualCorporation.html). That concept moved from the virtual world to reality as the result of Vermont's 2008 adoption of its virtual company law (see, www.sec.state.vt.us/corps/corpindex.htm, 11 Vt. Stat. Ann. Sections 3001 et seq., http://vermontvirtual.org/Vermont_legislation_–_as_passed, and www.nyls.edu/news_and_events/releases/virtual_company_project). The American Bar Association soon after published Virtual Incorporation: A Lawyer's Guide to the Formation of Virtual Corporations, in 2009 (see, www.abanet.org/abastore/index.cfm?section=main&fm=Product.AddToCart&pid=1620409) (The Lawyer's Guide).

In the vision of its creators, embodied in that law and described in that book, the “virtual company” would be a “model of business organization that is in sync with the turbulent world of software development,” without a “hierarchical governance model” or “investment in the structure of directors and officers.” Instead, the fashioners and promoters of this virtual company believe it “offers incorporators opportunities to establish relationships that fit the needs and style of Internet business life” (The Lawyer's Guide, p. 6). In contrast to the current business organization “menu” of partnerships or formal limited liability entities, such as a corporation or LLC, the authors of The Lawyer's Guide see a need for “a more flexible limited liability form for collaborative projects that have more transient participants, are less capital-based, and are less physical in nature” (The Lawyer's Guide, p. 6).

The Web site virtualcorporation.org, the portal of an organization through which people can operate virtual companies, provides more background on the perceived need for this new structure. It states: “Since we can communicate and collaborate electronically from anywhere, it's time to eliminate the artificial requirements of paper-based filings, of physical, face-to-face real-time meetings, and of physical company headquarters (while preserving, of course, the requirement of a corporate agent for service of process). Allowing the Secretary of State to prescribe document formats and delivery methods for electronic filing allows for a company formation process that can adapt to the needs of online companies and to the ever-changing array of online communication tools.”

Changing Times, Changing Needs

The Lawyer's Guide lists several reasons why the virtual company's proponents believe that structures created under traditional legal rules could be “awkward” for ventures that are not anchored to a physical existence, but exist (largely or even exclusively) through online cooperative efforts. (The Lawyer's Guide, p. 6). For example, online collaboration eliminates the need for an address. The reduced expenses of virtual work also reduce the need for initial capitalization of the venture. Founders' contributions of time and effort for their interest replace the legal fiction of contributing a nominal amount (the “proverbial peppercorn” despised by law students). The traditional corporate governance model of officers and directors elected for stated terms would be replaced by “self-selected” active participants, whose “effort level” and role will evolve with the project.

Certainly, these are all noble goals in an era when little in business has not tried to go virtual. The allure of reducing cost and complexity would have been appealing even at the height of the dot-com boom, because it was just that prospect that fueled the growth of early e-commerce in the 1990s. Moreover, democratizing the sometimes dense and seemingly hostile process of incorporation could eliminate the need for an attorney to act as a modern-day high priest or oracle to mediate between humans and the law ' along with cutting out high attorneys' fees. Indeed, much of the information for establishing a Vermont virtual company can be found not in law books, but at a wiki page at http://vermontvirtual.org/Formation, using the wiki model of online cooperation (see, http://en.wikipedia.org/wiki/Wiki).

But like much of e-commerce, is the virtual company really all that different from what already exists? Should entrepreneurs need to think about the unknown legal treatment and potential costs of choosing a new form of business organization, when something that already exists might work just as well? After all, it is popular wisdom that one should not buy the first version of a complex product, such as software or a car, to allow the creators to work out the bugs (rather than involuntarily participate in “live” field testing). A prudent investor should perhaps apply that principle all the more to something as complicated as legal rules.

In fact, drilling down on the law as passed reveals relatively little change to what has long been permitted by existing LLC law, much less corporate laws. Consider how the amendments that created the Vermont virtual
company mirror provisions of laws already on the books (using Delaware law, for comparison, because it is often cited as being in the forefront of modern corporate law). (See, http://vermontvirtual.org/Vermont_legislation_–_as_passed; http://www.leg.state.vt.us/docs/legdoc.cfm?URL=/docs/2008/acts/ACT190.HTM.)

Governing Document

The virtual company's “operating agreement” is defined as “the
agreement in writing any form of description of membership rights and obligations under section 3003 of this title, stored or depicted in any tangible or electronic medium, which is agreed to by the members, including amendments to the agreement.”

But that definition does not go as far as Delaware's “limited liability company agreement” (Section 18-101(7) of the Delaware Limited Liability Company Act (found generally at http://delcode.delaware.gov/title6/c018/index.shtml). Delaware permits oral agreements, and the granting of rights to third parties, neither of which is addressed by the Vermont law.

Delaware's law says:

(A)ny agreement (whether referred to as a limited liability company agreement, operating agreement or otherwise), written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business. A member or manager of a limited liability company or an assignee of a limited liability company interest is bound by the limited liability company agreement whether or not the member or manager or assignee executes the limited liability company agreement. ' A limited liability company agreement of a limited liability company having only 1 member shall not be unenforceable by reason of there being only 1 person who is a party to the limited liability company agreement. A limited liability company agreement may provide rights to any person, including a person who is not a party to the limited liability company agreement, to the extent set forth therein.

Meetings

The new Vermont law provides a very flexible structure for joint action, recognizing that all the participants may never be in the same place, or acting at the same time.

“Meeting” means any structured communications conducted by participants in person or through the use of electronic or telecommunications medium permitting simultaneous or sequentially structured communications for the purpose of reaching a collective agreement.

Yet Delaware LLC Act Section 18-302(d) already provides the same flexibility, including the right to act by a written consent, even if the consent is less than unanimous:

Unless otherwise provided in a limited liability company agreement, meetings of members may be held by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this subsection shall constitute presence in person at the meeting. Unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on, consented to or approved by members, the members may take such action without a meeting, without prior notice and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the members having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all members entitled to vote thereon were present and voted.

Documentation

The same '18-302(d) of the Delaware LLC Act has the same flexibility about the form of a record as Vermont provides in its definition of “document.” Vermont defines document as “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.”

As noted above, Delaware permits oral operating agreements, and (in the section describing voting records) states an evidentiary test that turns on the ability to retrieve and reproduce the information, rather than the form in which it was originally presented.

Duties of Members to Each Other and to Entity

Vermont's amendments do not attempt to change a fundamental legal concept in any business organization ' the “fiduciary duties” that the participants and the entity owe to each other not to abuse their position of trust.

Because Vermont does not have a separate “virtual company” statute, but rather has integrated the concept into its generally applicable corporate rules, presumably the “general” rules of fiduciary duty remain in effect without change.

Delaware, in contrast, not only has centuries of law and cases establishing those rules, but allows participants in a venture to modify the rules to suit their needs, if the nature of the relationship warrants such a fundamental change (as long as a basic rule of fairness remains, the “covenant of good faith and fair dealing”). See, '18-1101(e) of the Delaware LLC Act.

In short, I think we could look at each provision in Vermont's virtual company law and find the flexibility to do the same thing in the existing corporate and LLC laws of Delaware and, for that matter (in 2010) of most states' statutes. Whether through actions by written consent in lieu of a meeting, signatures in counterpart, telephonic meeting or broadened definitions of acceptable writings to include electronic communications by fax and e-mail, there is very little, if anything, that a traditional, “rules-bound” entity could not do under current law to capture the procedural flexibility touted by the virtual company founders.

What Vermont tries to offer, however, is a simplified, more accessible set of rules, so that typical entrepreneurs focusing on their own business can take advantage of the benefits of limited liability, without the expense or burden of retaining potentially expensive counsel to parse the corporate codes. While I can see that what Vermont offers can be provided in other states' rules, I can do that because I have practiced corporate law for 25 years ' the typical tech founder does not have that background.

To date, to my knowledge no other state has followed Vermont's lead with its own virtual company statute. That may not mean much ' the limited liability company, today's “business entity of choice,” took many years to become popular after it was first permitted in Wyoming in 1977. It was not until the IRS clarified its rules on how entities could be taxed with the “check the box” program first effective in 1997 that the LLC really took hold. Even the Web site of the Vermont Virtual Company lists only four such entities ' and two of them have yet to be established, and the fourth does not have a Web site (see, http://vermontvirtual.org/List_of_Virtual_Companies_with_links_to_their_online_headquarters).

Remember, It's a Virtual Bandwagon

Nonetheless, despite these possible benefits of the virtual company, I think that there may still be reasons to wait and see, as we say, before jumping on the virtual company bandwagon.

First, even though a collaborative effort may be “virtual,” it still must rely on the real world for many things if it is to conduct business and move beyond a glorified version of an online chat room. Whether it must obtain financing from traditional lenders, investors to supply capital, or simply enter into contracts with trade vendors, few firms today will do business with anyone who cannot provide basic documentation (especially in our security-conscious age, when even opening a simple bank account requires compliance with laws such as the USA Patriot Act and similar laws and regulations).

For an e-commerce firm, among which are many that often have no real-world existence, the need for legal documentation to establish its legitimacy is all the more important (see, “Dressing Up Your e-Business Up for Success,” in the June 2008 edition of e-Commerce Law & Strategy, for a discussion of how e-commerce firms can best present themselves to third parties; www.ljnonline.com/issues/ljn_ecommerce/ 25_2/news/150577-1.html). For example, even though Delaware permits limited liability companies to have an oral operating agreement ' ('18-101(7) of the Delaware Limited Liability Company Act) ' I would not recommend that any firm choose that route if it must document its existence to a third party in the future. Even though the “document lite approach” fits the virtual company ethos, the demands of those with whom virtual companies must do business may outweigh the “freedom to do less” that a virtual-company law provides.

Next, we cannot forget that states have a strong interest in collecting taxes on revenue generated by an activity (if it is otherwise taxable, i.e., not an intentional non-profit). While many e-commerce firms have unfortunately been unintentional non-profits, a successful virtual company will have to determine to which states and/or countries it or its owners will owe tax-reporting or payment responsibilities.

Since even virtual companies will act through human beings, the states where those humans are present may have the legal right to require such tax compliance (often referred to in short as “jurisdiction”). For true e-commerce sellers, tax planning involves trying to structure operations to avoid owing income, franchise and employment taxes in multiple states, and minimizing the expense of sales tax compliance. For virtual companies, the equivalent process should be no different.

More Fodder from Less?

I also think that there are some areas of company structuring where the “less is more” philosophy of the virtual company could create fodder for litigators. In other words, there are some legal needs that should never depend on “virtual” information. For example, while an idealistic view of participants in an enterprise may see them constantly adjusting the level of their activity (and, presumably, compensation, whether in the form of income or equity appreciation), my view, based on human nature, is less optimistic. Each actor will usually try to get more for him- or herself; if there is lack of complete clarity in organizational documents on how an economic pie will be divided, there will be disputes on what was intended to be done. In other words, I would not leave the parties' relative economic interests to anything that could be challenged based on the lack of finality or formality because of the effort to be “virtual,” or to adjust interests based on how “active” a participant has been in the project.

While negotiations over economic interests can certainly be conducted using all the virtual tools and processes described by the proponents of the virtual company, the parties' final ownership and operational control should be firmly documented in a way that no one can challenge should the future turn out differently than intended. Often, the results of such negotiations will be documented in very traditional ways, such as by a share certificate. (The sample operating agreement included in The Lawyer's Guide tries to capture this concept with a “points allocation” procedure, comparable to ones I have seen used in large professional-services firms. But “points” are in substance nothing more than a proxy for shares, albeit with different labels.)

Similarly, special provisions contemplated in a virtual company agreement, such as ones limiting access to the “project,” or providing special rights to project founders, can easily be accommodated by including similar, if not identical, rights in an LLC operating agreement, corporate bylaws, or pre-incorporation agreement describing how a new business will be operated.

Similarly, if any true real estate (in contrast to a domain name) is involved, the law (and title-insurance companies) generally requires hand-signed originals for all deed-book filings. While that step may do little beyond adding potential cost and delay, our real estate recording system that has endured since medieval England is not likely to be swayed by the needs of a legal structure still in its infancy. The attraction of a company without an office is also belied by the need for a registered office in the Vermont law, a prerequisite to allow third parties (or the state) to serve lawsuits or claims for taxes on a virtual company. Yet how is that different from the common situation of a real-world firm with offices in many states that employs a commercial service provider to act as its registered agent to receive all formal notices in an efficient manner?

Keeping Track, Looking Forward

Finally, there is one area (mentioned briefly above) in which a purely virtual presence will not be tolerated. Presumably, Vermont approved its virtual company law to attract businesses to that state ' just as it pioneered the domestic captive insurance industry, which now generates $25 million per year for the state (see, www.inc.com/magazine/20080701/a-haven-for-virtual-companies.html).

Since, by definition, virtual businesses will not have many employees, tangible assets or other traditional sources of revenue-generating ratables, Vermont should have a great interest in tracking each virtual entity, to ensure that the state's share in its economic benefits is protected (whether in the form of routine filing fees, or other tax revenue). Of course, this interest is no different than that of states such as Delaware or Nevada, whose friendly bureaucracies and laws have attracted many entities ' and created an industry of service firms and registered agents to assist out-of state firms in taking advantage of the state's benefits.

Those who support the bill see Vermont attracting a new generation of businesses rooted in the community. The sponsor of the virtual company bill, Woodstock Democrat Alison Clarkson, says such efforts are essential in a small rural state that cannot afford to woo companies with multimillion-dollar tax incentives.

“It's unlikely that we're ever going to attract a huge manufacturer,” she says. “We need to be savvy about our economic development” (see, www.inc.com/magazine/20080701/a-haven-for-virtual-companies.html).

Conclusion

So are the benefits of a virtual company imaginary, and not worth the effort? Of course not. As I mentioned earlier, cutting out inefficiencies and reducing costs have always been benefits of e-commerce (and don't hurt the bricks-and-mortar firms facing our current economic stasis). But achieving those goals through an as-yet untested legal structure unfortunately poses the risk of increased costs in dealing with those uncertainties. When existing business-organization laws allow firms to achieve those objectives easily, and with relatively little or no risk, using concepts that are well understood, and have withstood legal challenges, such uncertainty simply could create unnecessary expenses ' in the real world, rather than in the virtual one.

Entrepreneurs have always chafed against the formalities and procedures demanded of them by their attorneys and, more generally, by business laws. Who hasn't had to keep reminding clients of the importance of signing and returning annual minutes ' again and again and again?

This is even more so for the tech sector, and e-commerce founders. After all, they created an industry by thinking outside the proverbial “box,” so why should their creativity be constrained by legal rules created for the age of the steam engine?

From Virtual to Reality

That paradox lies behind the concept of the “virtual company” (see, http://en.wikipedia.org/wiki/Virtual_business#Virtual_corporations, http://virtualcorporation.org, and http://dotank.nyls.edu/VisualCorporation.html). That concept moved from the virtual world to reality as the result of Vermont's 2008 adoption of its virtual company law (see, www.sec.state.vt.us/corps/corpindex.htm, 11 Vt. Stat. Ann. Sections 3001 et seq., http://vermontvirtual.org/Vermont_legislation_–_as_passed, and www.nyls.edu/news_and_events/releases/virtual_company_project). The American Bar Association soon after published Virtual Incorporation: A Lawyer's Guide to the Formation of Virtual Corporations, in 2009 (see, www.abanet.org/abastore/index.cfm?section=main&fm=Product.AddToCart&pid=1620409) (The Lawyer's Guide).

In the vision of its creators, embodied in that law and described in that book, the “virtual company” would be a “model of business organization that is in sync with the turbulent world of software development,” without a “hierarchical governance model” or “investment in the structure of directors and officers.” Instead, the fashioners and promoters of this virtual company believe it “offers incorporators opportunities to establish relationships that fit the needs and style of Internet business life” (The Lawyer's Guide, p. 6). In contrast to the current business organization “menu” of partnerships or formal limited liability entities, such as a corporation or LLC, the authors of The Lawyer's Guide see a need for “a more flexible limited liability form for collaborative projects that have more transient participants, are less capital-based, and are less physical in nature” (The Lawyer's Guide, p. 6).

The Web site virtualcorporation.org, the portal of an organization through which people can operate virtual companies, provides more background on the perceived need for this new structure. It states: “Since we can communicate and collaborate electronically from anywhere, it's time to eliminate the artificial requirements of paper-based filings, of physical, face-to-face real-time meetings, and of physical company headquarters (while preserving, of course, the requirement of a corporate agent for service of process). Allowing the Secretary of State to prescribe document formats and delivery methods for electronic filing allows for a company formation process that can adapt to the needs of online companies and to the ever-changing array of online communication tools.”

Changing Times, Changing Needs

The Lawyer's Guide lists several reasons why the virtual company's proponents believe that structures created under traditional legal rules could be “awkward” for ventures that are not anchored to a physical existence, but exist (largely or even exclusively) through online cooperative efforts. (The Lawyer's Guide, p. 6). For example, online collaboration eliminates the need for an address. The reduced expenses of virtual work also reduce the need for initial capitalization of the venture. Founders' contributions of time and effort for their interest replace the legal fiction of contributing a nominal amount (the “proverbial peppercorn” despised by law students). The traditional corporate governance model of officers and directors elected for stated terms would be replaced by “self-selected” active participants, whose “effort level” and role will evolve with the project.

Certainly, these are all noble goals in an era when little in business has not tried to go virtual. The allure of reducing cost and complexity would have been appealing even at the height of the dot-com boom, because it was just that prospect that fueled the growth of early e-commerce in the 1990s. Moreover, democratizing the sometimes dense and seemingly hostile process of incorporation could eliminate the need for an attorney to act as a modern-day high priest or oracle to mediate between humans and the law ' along with cutting out high attorneys' fees. Indeed, much of the information for establishing a Vermont virtual company can be found not in law books, but at a wiki page at http://vermontvirtual.org/Formation, using the wiki model of online cooperation (see, http://en.wikipedia.org/wiki/Wiki).

But like much of e-commerce, is the virtual company really all that different from what already exists? Should entrepreneurs need to think about the unknown legal treatment and potential costs of choosing a new form of business organization, when something that already exists might work just as well? After all, it is popular wisdom that one should not buy the first version of a complex product, such as software or a car, to allow the creators to work out the bugs (rather than involuntarily participate in “live” field testing). A prudent investor should perhaps apply that principle all the more to something as complicated as legal rules.

In fact, drilling down on the law as passed reveals relatively little change to what has long been permitted by existing LLC law, much less corporate laws. Consider how the amendments that created the Vermont virtual
company mirror provisions of laws already on the books (using Delaware law, for comparison, because it is often cited as being in the forefront of modern corporate law). (See, http://vermontvirtual.org/Vermont_legislation_–_as_passed; http://www.leg.state.vt.us/docs/legdoc.cfm?URL=/docs/2008/acts/ACT190.HTM.)

Governing Document

The virtual company's “operating agreement” is defined as “the
agreement in writing any form of description of membership rights and obligations under section 3003 of this title, stored or depicted in any tangible or electronic medium, which is agreed to by the members, including amendments to the agreement.”

But that definition does not go as far as Delaware's “limited liability company agreement” (Section 18-101(7) of the Delaware Limited Liability Company Act (found generally at http://delcode.delaware.gov/title6/c018/index.shtml). Delaware permits oral agreements, and the granting of rights to third parties, neither of which is addressed by the Vermont law.

Delaware's law says:

(A)ny agreement (whether referred to as a limited liability company agreement, operating agreement or otherwise), written, oral or implied, of the member or members as to the affairs of a limited liability company and the conduct of its business. A member or manager of a limited liability company or an assignee of a limited liability company interest is bound by the limited liability company agreement whether or not the member or manager or assignee executes the limited liability company agreement. ' A limited liability company agreement of a limited liability company having only 1 member shall not be unenforceable by reason of there being only 1 person who is a party to the limited liability company agreement. A limited liability company agreement may provide rights to any person, including a person who is not a party to the limited liability company agreement, to the extent set forth therein.

Meetings

The new Vermont law provides a very flexible structure for joint action, recognizing that all the participants may never be in the same place, or acting at the same time.

“Meeting” means any structured communications conducted by participants in person or through the use of electronic or telecommunications medium permitting simultaneous or sequentially structured communications for the purpose of reaching a collective agreement.

Yet Delaware LLC Act Section 18-302(d) already provides the same flexibility, including the right to act by a written consent, even if the consent is less than unanimous:

Unless otherwise provided in a limited liability company agreement, meetings of members may be held by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this subsection shall constitute presence in person at the meeting. Unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on, consented to or approved by members, the members may take such action without a meeting, without prior notice and without a vote if a consent or consents in writing, setting forth the action so taken, shall be signed by the members having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all members entitled to vote thereon were present and voted.

Documentation

The same '18-302(d) of the Delaware LLC Act has the same flexibility about the form of a record as Vermont provides in its definition of “document.” Vermont defines document as “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.”

As noted above, Delaware permits oral operating agreements, and (in the section describing voting records) states an evidentiary test that turns on the ability to retrieve and reproduce the information, rather than the form in which it was originally presented.

Duties of Members to Each Other and to Entity

Vermont's amendments do not attempt to change a fundamental legal concept in any business organization ' the “fiduciary duties” that the participants and the entity owe to each other not to abuse their position of trust.

Because Vermont does not have a separate “virtual company” statute, but rather has integrated the concept into its generally applicable corporate rules, presumably the “general” rules of fiduciary duty remain in effect without change.

Delaware, in contrast, not only has centuries of law and cases establishing those rules, but allows participants in a venture to modify the rules to suit their needs, if the nature of the relationship warrants such a fundamental change (as long as a basic rule of fairness remains, the “covenant of good faith and fair dealing”). See, '18-1101(e) of the Delaware LLC Act.

In short, I think we could look at each provision in Vermont's virtual company law and find the flexibility to do the same thing in the existing corporate and LLC laws of Delaware and, for that matter (in 2010) of most states' statutes. Whether through actions by written consent in lieu of a meeting, signatures in counterpart, telephonic meeting or broadened definitions of acceptable writings to include electronic communications by fax and e-mail, there is very little, if anything, that a traditional, “rules-bound” entity could not do under current law to capture the procedural flexibility touted by the virtual company founders.

What Vermont tries to offer, however, is a simplified, more accessible set of rules, so that typical entrepreneurs focusing on their own business can take advantage of the benefits of limited liability, without the expense or burden of retaining potentially expensive counsel to parse the corporate codes. While I can see that what Vermont offers can be provided in other states' rules, I can do that because I have practiced corporate law for 25 years ' the typical tech founder does not have that background.

To date, to my knowledge no other state has followed Vermont's lead with its own virtual company statute. That may not mean much ' the limited liability company, today's “business entity of choice,” took many years to become popular after it was first permitted in Wyoming in 1977. It was not until the IRS clarified its rules on how entities could be taxed with the “check the box” program first effective in 1997 that the LLC really took hold. Even the Web site of the Vermont Virtual Company lists only four such entities ' and two of them have yet to be established, and the fourth does not have a Web site (see, http://vermontvirtual.org/List_of_Virtual_Companies_with_links_to_their_online_headquarters).

Remember, It's a Virtual Bandwagon

Nonetheless, despite these possible benefits of the virtual company, I think that there may still be reasons to wait and see, as we say, before jumping on the virtual company bandwagon.

First, even though a collaborative effort may be “virtual,” it still must rely on the real world for many things if it is to conduct business and move beyond a glorified version of an online chat room. Whether it must obtain financing from traditional lenders, investors to supply capital, or simply enter into contracts with trade vendors, few firms today will do business with anyone who cannot provide basic documentation (especially in our security-conscious age, when even opening a simple bank account requires compliance with laws such as the USA Patriot Act and similar laws and regulations).

For an e-commerce firm, among which are many that often have no real-world existence, the need for legal documentation to establish its legitimacy is all the more important (see, “Dressing Up Your e-Business Up for Success,” in the June 2008 edition of e-Commerce Law & Strategy, for a discussion of how e-commerce firms can best present themselves to third parties; www.ljnonline.com/issues/ljn_ecommerce/ 25_2/news/150577-1.html). For example, even though Delaware permits limited liability companies to have an oral operating agreement ' ('18-101(7) of the Delaware Limited Liability Company Act) ' I would not recommend that any firm choose that route if it must document its existence to a third party in the future. Even though the “document lite approach” fits the virtual company ethos, the demands of those with whom virtual companies must do business may outweigh the “freedom to do less” that a virtual-company law provides.

Next, we cannot forget that states have a strong interest in collecting taxes on revenue generated by an activity (if it is otherwise taxable, i.e., not an intentional non-profit). While many e-commerce firms have unfortunately been unintentional non-profits, a successful virtual company will have to determine to which states and/or countries it or its owners will owe tax-reporting or payment responsibilities.

Since even virtual companies will act through human beings, the states where those humans are present may have the legal right to require such tax compliance (often referred to in short as “jurisdiction”). For true e-commerce sellers, tax planning involves trying to structure operations to avoid owing income, franchise and employment taxes in multiple states, and minimizing the expense of sales tax compliance. For virtual companies, the equivalent process should be no different.

More Fodder from Less?

I also think that there are some areas of company structuring where the “less is more” philosophy of the virtual company could create fodder for litigators. In other words, there are some legal needs that should never depend on “virtual” information. For example, while an idealistic view of participants in an enterprise may see them constantly adjusting the level of their activity (and, presumably, compensation, whether in the form of income or equity appreciation), my view, based on human nature, is less optimistic. Each actor will usually try to get more for him- or herself; if there is lack of complete clarity in organizational documents on how an economic pie will be divided, there will be disputes on what was intended to be done. In other words, I would not leave the parties' relative economic interests to anything that could be challenged based on the lack of finality or formality because of the effort to be “virtual,” or to adjust interests based on how “active” a participant has been in the project.

While negotiations over economic interests can certainly be conducted using all the virtual tools and processes described by the proponents of the virtual company, the parties' final ownership and operational control should be firmly documented in a way that no one can challenge should the future turn out differently than intended. Often, the results of such negotiations will be documented in very traditional ways, such as by a share certificate. (The sample operating agreement included in The Lawyer's Guide tries to capture this concept with a “points allocation” procedure, comparable to ones I have seen used in large professional-services firms. But “points” are in substance nothing more than a proxy for shares, albeit with different labels.)

Similarly, special provisions contemplated in a virtual company agreement, such as ones limiting access to the “project,” or providing special rights to project founders, can easily be accommodated by including similar, if not identical, rights in an LLC operating agreement, corporate bylaws, or pre-incorporation agreement describing how a new business will be operated.

Similarly, if any true real estate (in contrast to a domain name) is involved, the law (and title-insurance companies) generally requires hand-signed originals for all deed-book filings. While that step may do little beyond adding potential cost and delay, our real estate recording system that has endured since medieval England is not likely to be swayed by the needs of a legal structure still in its infancy. The attraction of a company without an office is also belied by the need for a registered office in the Vermont law, a prerequisite to allow third parties (or the state) to serve lawsuits or claims for taxes on a virtual company. Yet how is that different from the common situation of a real-world firm with offices in many states that employs a commercial service provider to act as its registered agent to receive all formal notices in an efficient manner?

Keeping Track, Looking Forward

Finally, there is one area (mentioned briefly above) in which a purely virtual presence will not be tolerated. Presumably, Vermont approved its virtual company law to attract businesses to that state ' just as it pioneered the domestic captive insurance industry, which now generates $25 million per year for the state (see, www.inc.com/magazine/20080701/a-haven-for-virtual-companies.html).

Since, by definition, virtual businesses will not have many employees, tangible assets or other traditional sources of revenue-generating ratables, Vermont should have a great interest in tracking each virtual entity, to ensure that the state's share in its economic benefits is protected (whether in the form of routine filing fees, or other tax revenue). Of course, this interest is no different than that of states such as Delaware or Nevada, whose friendly bureaucracies and laws have attracted many entities ' and created an industry of service firms and registered agents to assist out-of state firms in taking advantage of the state's benefits.

Those who support the bill see Vermont attracting a new generation of businesses rooted in the community. The sponsor of the virtual company bill, Woodstock Democrat Alison Clarkson, says such efforts are essential in a small rural state that cannot afford to woo companies with multimillion-dollar tax incentives.

“It's unlikely that we're ever going to attract a huge manufacturer,” she says. “We need to be savvy about our economic development” (see, www.inc.com/magazine/20080701/a-haven-for-virtual-companies.html).

Conclusion

So are the benefits of a virtual company imaginary, and not worth the effort? Of course not. As I mentioned earlier, cutting out inefficiencies and reducing costs have always been benefits of e-commerce (and don't hurt the bricks-and-mortar firms facing our current economic stasis). But achieving those goals through an as-yet untested legal structure unfortunately poses the risk of increased costs in dealing with those uncertainties. When existing business-organization laws allow firms to achieve those objectives easily, and with relatively little or no risk, using concepts that are well understood, and have withstood legal challenges, such uncertainty simply could create unnecessary expenses ' in the real world, rather than in the virtual one.