From Founder To Director: What Changes When You Incorporate?

Incorporating your business is a big moment. What may have started as an idea, side project or small operation is now officially a company.

But along with that new company comes a new role. If you are appointed as a director, you are no longer just the person building the business and keeping things moving. You now have legal responsibilities for how the company is run and how its decisions are made.

Day to day, not much may feel different. You might still be working with the same people, serving the same customers and tackling the same growing to-do list. Legally, though, your position has changed.

What Changes When You Incorporate?

Before incorporating, you may have operated as a sole trader. In that structure, there is generally no legal separation between you and the business.

Once registered, a company becomes its own legal entity. It can enter contracts, own assets and take on debts in its own name. As a director, you are no longer making decisions only for yourself. You are making them on behalf of the company.

It is worth making one distinction clear: incorporating does not automatically make every founder a director. You become a director when you are appointed to that role.

A founder may also be a shareholder or employee of the company, but these roles are different. “Founder” describes the person who started the business. A shareholder owns shares in the company. A director holds a recognised legal position with duties under the Corporations Act 2001 (Cth).

In many startups, the same person will be all three. However, being the founder or majority shareholder does not remove the responsibilities that come with being a director.

Who Is Legally Considered A Director?

The most obvious example is someone who has been formally appointed as a director. However, the legal definition can extend further than the names recorded on ASIC’s register.

Under section 9AC of the Corporations Act, a director can also include someone who acts in the position of a director without being validly appointed. This person is commonly known as a de facto director.

It can also include someone whose instructions or wishes the appointed directors are accustomed to following. This person is often called a shadow director. However, someone will not become a shadow director merely because the directors follow advice properly given as part of that person’s professional role or business relationship with the company.

This could matter where one founder is formally appointed while another continues making major company decisions behind the scenes. Calling yourself an adviser, consultant or founder will not necessarily prevent you from being treated as a director if your actual role suggests otherwise.

In other words, the law looks at what you do, not just the title you use.

What Are The Main Directors’ Duties?

The core statutory duties are set out in sections 180 to 184 of the Corporations Act. They apply whether the company is a fast-growing startup or a small business with one shareholder and director.

Acting With Care And Diligence

Directors must exercise the level of care and diligence that a reasonable person would exercise in their position.

This means understanding important decisions before approving them, asking questions where something is unclear and properly considering major risks. Signing an expensive long-term agreement without reading it or checking whether the company can afford it may raise concerns.

The law does not expect every commercial decision to succeed. Under the business judgment rule, a director may be taken to have met their care and diligence duty for a particular business decision if they acted in good faith and for a proper purpose, had no material personal interest, appropriately informed themselves and rationally believed the decision was in the company’s best interests. It is not blanket protection for every action a director takes.

Acting In Good Faith And For A Proper Purpose

Directors must act in good faith in the company’s best interests and use their powers for a proper purpose.

For founders, this means recognising that the company’s interests may not always be identical to their own. A director should not, for example, redirect a company opportunity to another business they own or issue shares mainly to weaken a co-founder’s voting power.

Not Improperly Using Your Position

A director must not improperly use their position to gain an advantage for themselves or someone else, or to cause harm to the company.

This could include using company employees for a separate personal venture, directing the company into an unfavourable deal with another business the founder owns or using company funds for personal purposes without a proper basis.

Directors can still receive a salary, be reimbursed for legitimate expenses or enter transactions with the company. The important point is that these arrangements should be properly approved, recorded and consistent with the company’s interests.

Not Improperly Using Company Information

Directors must not improperly use information obtained through their position to benefit themselves or someone else, or to harm the company.

For a startup, that information might include customer lists, financial data, pricing strategies, unreleased product plans or details of a new commercial opportunity.

This duty can continue after someone stops being a director, so leaving the company does not necessarily give a former founder the right to take confidential information and use it elsewhere.

Disclosing Personal Interests

Founders often wear several hats, which means conflicts can arise. A director might own another business dealing with the company, negotiate their own remuneration or have a financial interest in a proposed transaction.

Where a director has a material personal interest in a matter relating to the company’s affairs, they will generally need to disclose the nature and extent of that interest to the other directors, subject to exceptions in the Act.

Having a conflict does not automatically mean the transaction cannot proceed. However, it should be disclosed and managed rather than ignored. Whether the director can take part in the discussion or vote will depend on the type of company, the Corporations Act and any rules in the company’s constitution.

Certain dishonest or reckless breaches involving good faith, proper purpose, use of position or use of information can also lead to criminal consequences under section 184.

Directors Need To Stay Informed And Keep Proper Records

Being a director does not mean personally handling every contract, invoice or operational decision. Founders can divide responsibilities and rely on employees and professional advisers where it is reasonable to do so.

However, delegation does not remove a director’s duties.

A founder cannot necessarily avoid responsibility by saying that their co-founder handled the finances, the accountant prepared the numbers or they were only responsible for the product.

Directors are expected to understand what the company is doing, take part in important decisions and remain informed about its financial position. They should know what major debts and liabilities the company has and whether it can meet its commitments.

The company must also keep financial records that correctly record and explain its transactions, financial position and performance. A director can contravene the Corporations Act if they fail to take reasonable steps to ensure the company keeps adequate records.

This does not mean every founder needs to become a finance expert. It does mean reading the information provided, asking questions where the figures do not make sense and paying attention when something appears to be going wrong.

The Duty To Prevent Insolvent Trading

A director also has a specific duty to prevent the company from trading while insolvent.

A company is generally insolvent when it cannot pay its debts as and when they fall due. Under section 588G of the Corporations Act, directors may face liability where the company incurs a debt while insolvent, or becomes insolvent by taking on that debt, and there were reasonable grounds to suspect insolvency.

Possible warning signs include repeatedly paying suppliers late, missing payroll, defaulting on loan repayments or relying on an uncertain funding round to pay debts that are already due.

A temporary cash-flow problem does not automatically mean the company is insolvent. However, directors should not keep taking on debts without understanding whether the company can pay them.

Safe harbour protection may be available in some circumstances where an eligible director begins developing and taking a course of action that is reasonably likely to lead to a better outcome for the company. Directors should seek qualified advice as early as possible where insolvency is a concern.

Directors must also be careful about disposing of company assets when the company is insolvent or becomes insolvent because of the transaction. The Act contains a duty to prevent creditor-defeating dispositions, which can include disposing of company property for less than its proper value in a way that prevents, hinders or significantly delays the property becoming available to creditors during a winding up.

What Can Happen If A Director Breaches Their Duties?

The consequences will depend on the duty involved, the seriousness of the conduct and the loss caused.

A director may face civil penalties, compensation orders or disqualification from managing companies. Certain dishonest or reckless conduct may also lead to criminal consequences. In some circumstances, a director may become personally responsible for company debts.

That does not mean directors should become afraid to make decisions or take commercial risks. A business decision is not automatically a breach simply because it does not work out.

The focus is on how the decision was made: whether the director acted honestly, considered the available information, managed any personal interests and made the decision for a proper company purpose.

Getting The Director Role Right

Directors’ duties are easier to manage when good habits are built into the company early.

Read important contracts before approving them. Keep records of major decisions and disclose personal interests as soon as they arise. Stay familiar with the company’s financial position, even where another founder or accountant handles the day-to-day figures.

It is also important to understand how decisions are meant to be made within the company. A company constitution and shareholders’ agreement can clarify each founder’s role, which decisions require approval and how conflicts or disagreements will be handled.

These documents do not replace the duties imposed by law, but they can make it easier for founders to understand their authority and avoid decisions being made too informally.

From Founder To Director

Incorporating may not change what your working day looks like. You may still be speaking with customers, developing the product and trying to work through a never-ending list of priorities.

What changes is the legal position you hold while doing those things.

Once appointed as a director, you are making decisions for a separate company. You need to act carefully, put the company’s interests first, use your position and information properly, remain informed and take action when the company is facing financial difficulty.

If you are incorporating a business or bringing a co-founder into an existing company, getting the right legal foundations in place can make these responsibilities easier to manage. A legal expert can assist with company registration, company constitutions, shareholders’ agreements and other arrangements setting out how the company will be owned and run.

If you would like a consultation on your director duties, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.