The term "cloak" is used to categorize a number of initiatives taken to protect assets. These initiatives may or may not prove to be legitimate of the facts. They nonetheless are not uncommon. Such cloaks have the effect of disguising the identity or characteristics of the wearer. The maxim caveat venditor or seller beware has cautionary application to anyone who deals with a startup or startup group.
The use of a trustee corporation is often advantageous in commercial real estate and property development. A property is held by a corporation as a bare legal trustee subject to a trust agreement in favour of certain beneficial owners. The property is registered in the name of the trustee corporation and the beneficial owners do not appear on title. There are business reasons for the structure including the avoidance of property purchase tax on subsequent sale by selling the shares of the bare trustee rather than the land. A bare trust may also provide for a single owner in a co-ownership arrangement thereby simplifying title issues. The trustee corporation incurs the liabilities to third parties but has no interest of any significant or exigible value in the land. If the project is successful, the profits flow through the trustee corporation to the beneficial owners. If not, the beneficial owners may allow the trustee corporation to be found responsible to third party claimants and creditors. Although this technique has enjoyed some success, aggressive claimants and creditors have pursued the beneficial owners through litigation on various legal theories.
Startup corporations are often related. They can be related by vertical relationship as a parent and subsidiary. They can be related by horizontal relationship such as affiliated or sister startup corporations. Corporations may operate as group enterprise and even issue consolidated financial statements. they may have a number of undisclosed contractual relations pursuant to which services are rendered and payment made within the group enterprise. The liabilities to third party claimants and creditors for the group are sometimes assumed by a particular corporate member as a front for the group. The front corporation may issue the purchase orders and sign the contracts for certain business activities. The suppliers and contracting parties may not be alive to the significance of the offer and acceptance and assume that the apparent fiscal health of the group of startup companies is a common financial characteristic of all of its members. The front corporation may collapse under the burden of debt while other startup members of the group hold assets and carry on unrelated business. Given the uncertain status of the enterprise entity doctrine as a ground for piercing the corporate veil, sophisticated suppliers and creditors may be expected to be cautious in entering into contracts with creditworthy entities or requesting guarantees or indemnities from affiliates.
Thinly Capitalized Corporations
Some startup businesses may attempt to leave as little surplus capital at risk in an operating startup company as possible. They are thinly capitalized. Inadequate or thin capitalization has on occasion been referred to as supporting the piercing of a corporate veil but disregarded in other cases. Surplus capital can, as mentioned, be paid out by way of dividends when the startup business is profitable leaving the company not insolvent but, with the benefit of hindsight, inadequately capitalized to meet future adversity. In some instances, corporations have been known to dividend out cash on an annual basis to the shareholders or a holding company who in turn have loaned the money on a secured basis to the startup corporation. This will put the related party in a position to obtain priority over the creditors in the event the startup corporation becomes insolvent at a future date.