Corporate Governance

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Forming and Organizing a Corporation (CA)

by Practical Law Corporate & Securities

Maintained • California

This Practice Note explains the process, steps, and documents required to form a for-profit corporation in California. It discusses initial considerations, pre-incorporation logistics, drafting and filing formation documents, post-incorporation logistics, and other important considerations.

Contents

Pre-Incorporation Planning: Initial Considerations

State of Incorporation

Special Types of California Business Corporations

Statutory Close Corporation

Professional Corporation

Social Purpose Corporation

Benefit Corporation

C- or S-Corporation

Name of Corporation

Requirements and Restrictions

Name Availability

Name Reservation

Fictitious Business Names

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Pre-Incorporation Logistics

Ordering a Minute Book

Determining Whether to Use a Service Company to File the Articles of Incorporation

Determining Whether the Filing Needs to be Precleared or Expedited

Choosing the Initial Agent for Service of Process

Choosing the Incorporators

Choosing the Initial Directors

Choosing the Initial Officers

Confirming the Availability of Signatories

Draft Formation and Organizational Documents

Articles of Incorporation

Required Provisions

Optional Provisions

Filing the Articles of Incorporation

Statement of Information

Bylaws

Organizational Action

Issuance of Shares

Shareholder Agreements

Close Corporations

Obtaining Signatures and Delivering Documents

Post-Incorporation Logistics

Tax Credits and Incentives

Further Assistance

Pre-Incorporation Planning: Initial Considerations

When forming a business in California, the first step is deciding what type of entity is best (for example, a corporation, partnership, or limited liability company). The best entity form depends on structure, liability, tax, and management

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considerations (see Choosing an Entity Comparison Chart (CA), and Practice Note, Choice of Entity: Tax Issues). Corporations are a common form for entities that:

• Have a formal management structure.

• Are currently or may become a public company.

• Have owners (shareholders) or management (directors and officers) that desire:

• predictable and recognized legal structure;

• limited liability; and

• relative flexibility in transferring ownership interests; and

• perpetual existence.

When deciding to incorporate, there are several threshold issues to consider. The following is a list of key questions to ans wer and decisions to make before forming a California corporation.

State of Incorporation

Before forming a corporation, it is necessary to determine the preferred state of incorporation. Corporations are generally governed by the laws of the state of incorporation. The California Corporations Code (Code) (Cal. Corp. Code §§ 1 et seq.) governs the organization of, and procedural rules for transactions involving, a California corporation and includes provisions concerning:

• Filing requirements.

• The f of the corporation’s directors and officers.

• The corporation’s shares and shareholder rights.

• Mergers, conversions, reorganizations, and asset sales.

Many corporations based in California chose California as the state of incorporation. Delaware is also a common state for incorporation for corporations based in California for a variety of reasons:

• Low franchise taxes.

• Ease of filing and online services.

• Well-developed body of corporate law.

• Respected judicial bench in corporate law.

• Business-friendly statutes and decisions.

A corporation based in California but formed in another state (such as Delaware) must pay additional fees to register as a foreign entity if it is doing business in California. For more information on qualifying a foreign entity to do business in

California, see Qualifying a Foreign Entity to do Business in California Checklist.

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The shareholders should consider where the corporation will primarily transact its business and if there are any business, tax, social, or policy reasons for choosing a particular state. If the corporation is going to conduct a regulated business in a state other than California, it may be easier to obtain the necessary state licenses if it is a domestic corporation within the state. For example, if someone living in California was considering forming a corporation that would primarily do business across the border in Nevada, then Nevada law may be more appropriate. For more information about choosing California or Delaware as a jurisdiction of incorporation, see Choosing a Jurisdiction Comparison Chart: C-Corporations (DE and CA) and Choosing a Jurisdiction Comparison Chart: S-Corporations (DE and CA).

Special Types of California Business Corporations

A California corporation may choose to be classified as one or more of the special types of corporation listed below (for example, a close corporation may also be a social purpose corporation) provided its articles of incorporation satisfy the statutory requirements for that classification:

• Statutory close corporation.

• Professional corporation.

• Social purpose corporation.

• Benefit corporation.

Statutory Close Corporation A close corporation is a corporation that conforms to certain statutory requirements (including a required statement in the articles of incorporation) and does not have:

• More than 35 shareholders of record.

• Publicly traded shares.

(Cal. Corp. Code §§ 158(a), 418(c), and 421.) A close corporation can be a practical alternative to a partnership by allowing a limited number of individuals that actively participate in the corporation’s operations to take advantage of the corporate form, which includes the limitation of personal liability for the acts of the corporation. For further discussion of the potential advantages and disadvantages of close corporations, see Cal. Prac. Guide Corps. Ch. 3-D §§ 3:245 et seq. and Cal. Prac. Guide Corps. Ch. 3-D §§ 3:269 et seq.

Professional Corporation The Moscone-Knox Professional Corporation Act (Cal. Corp. Code §§ 13400 et seq.) allows the formation of a corporation to render certain licensed professional services, but only through licensed individuals (Cal. Corp. Code § 13405(a)). In addition to being subject to general corporation law, a professional corporation must also comply with the regulations of the state agency that licenses the professional activity (Cal. Corp. Code §13410(a) and Cal. Prac. Guide Corps. Ch. 2-E § 2:245). A professional corporation can provide an advantage over other entity forms, such as a partnership, for individuals engaged in licensed activities subject to malpractice claims. While an individual cannot be absolved of personal liability for their own malpractice, the professional corporation does limit that individual’s vicarious liability for the malpractice of other practicing professionals in the corporation (T & R Foods, Inc. v. Rose (1996) 47 Cal. App.4th Supp. 1, 8-10). For further discussion of considerations unique to professional corporations, see Cal. Prac. Guide Corps. Ch. 2-E § 2:272.

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Social Purpose Corporation A social purpose corporation (SPC) is a for-profit corporation that, under the Social Purpose Corporations Act (Cal. Corp. Code §§ 2500 et seq.) may also pursue environmental or other public purpose objectives (Cal. Corp. Code § 2602(b)(2)). This additional purpose may be appealing to consumers or investors, depending on the corporation’s market and sources of capital. The SPC’s annual report must include a management discussion and analysis addressing the SPC’s public purpose (Cal. Corp. Code § 3500(b)). For further discussion of SPCs, see Cal. Prac. Guide Corps. Ch. 9-A §§ 9:1 et seq.

Benefit Corporation A benefit corporation is a for-profit corporation that has the purpose of creating general public benefit (Cal. Corp. Code § 14610(a)). Unlike directors of other types of corporations, a benefit corporation’s directors are not required to perform their duties in the best interests of shareholders (although they must perform their duties in the best interests of the corporation, and consider the impact of any action or proposed action on shareholders) (Cal. Corp. Code § 14620(a), (b)(1)). This allows the benefit corporation to address and promote socially desirable goals while balancing the economic benefits of the shareholders. The benefit corporation’s annual report to shareholders must assess the corporation’s social and environmental performance, using a third-party standard consistently applied (Cal. Corp. Code § 14630(a)(2)). For further discussion of benefit corporations, see Cal. Prac. Guide Corps. Ch. 9(II)-A §§ 9:500 et seq.

C- or S-Corporation

The most common corporate form is the C-corporation. References to corporations are usually to C-corporations.

C-corporation income is generally subject to two levels of US federal income tax:

• At the corporate level when earned.

• At the shareholder level when profits are distributed as dividends or other distributions.

Corporations can avoid this double taxation by electing to be treated as an S-corporation, which is a pass-through entity for

US federal income tax purposes. An S-corporation does not pay an entity level tax. Profits and losses instead pass through to its shareholders that report and are taxed on their respective share of those items on their own US federal income tax returns, whether or not distributed (see Practice Note, Choice of Entity: Tax Issues). However, this form of corporation may not always be available because there are limitations on the availability of this election, such as restrictions on the number, type, and residency of shareholders. While California recognizes, for state purposes, the S-corporation election for federal purposes, it still imposes a 1.5% franchise tax on the corporation’s net income (Cal. Rev. & Tax. Code § 23802(b)(1) and Cal. Prac. Guide Corps. Ch. 2-C § 2:120). For more information on S-corporation US federal taxation matters, see Practice Note, Taxation of S-Corporations. Basic California state tax information is available on the California Franchise Tax Board’s website (see California Franchise Tax Board). Parties should consult with a tax attorney or certified public accountant familiar with both state and federal taxation issues before forming an entity.

Name of Corporation

Before drafting formation documents or making any filings, determine the name of the corporation.

Requirements and Restrictions The name of a California corporation must not:

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• Contain the words “bank”, “trust”, “trustee”, or related words unless approved by the Commissioner of Business Oversight.

• Be likely to mislead the public, as determined by the California Secretary of State (SOS).

• Be the same or deceptively resemble a corporate name already on record, unless the holder of the original name consents to its use and the SOS finds that the public is not likely to be misled.

(Cal. Corp. Code §§ 201(a), (b).) For a discussion of name restrictions and guidelines generally, including name restrictions of other forms of corporations, s uch as close corporations and social purpose corporations, see Cal. Prac. Guide Corps. Ch. 3-H §§ 3:402 et seq.

Name Availability To avoid possible delays in filing the articles of organization, parties can informally check the availability of a business name by performing a search on the SOS website (see Secretary of State: Business Search). Parties can formally check the availability of a business name by:

• Mailing a Secretary of State: Name Availability Inquiry Letter to the SOS.

• For parties that regularly check name availability, setting up a prepay account with the SOS for Priority Telephone Service, by email to Secretary of State: Email Prepaid Accounts or telephone at (916) 653–1233.

Parties should have backup name choices in case a name is already taken or rejected. If an attorney is handling the name availability search or a name reservation filing, the attorney should have the alternate names to save time and avoid having to contact the client each time a name is rejected. Checking the name does not reserve or confer any rights to the name. The fact that a name is available does not mean that it satisfies the statutory requirements set out in the Code or that the SOS will approve it. Parties should not take any action in reliance on the availability of a name. If the corporation intends to use its name as a trademark, service mark, domain name, or trade name, consider running a trademark and copyright search to see if another business has registered the name. These searches can be conducted for

free online at the United States Patent and Trademark Office.

Name Reservation Parties can reserve a business name in advance for a period of up to 60 days (Cal. Corp. Code § 201(d) and see Secretary of State: Name Reservation Request). The Code does not permit the same or a deceptively similar name to be reserved for the same party for consecutive 60 day periods (Cal. Corp. Code § 201(d)). To renew a previously reserved name, a party must wait at least one business day before submitting a new name reservation request (if the name has not been reserved by another party in the interval). For more information on filing a name reservation request, including filing and payment methods, filing and additional fees, expedited filing, and required supporting documents, see Practice Note, Filing Documents with the Secretary of State (CA). The SOS reviews names for compliance when the articles of incorporation are filed. Parties should not rely on a reserved business name, as reserving the name does not guarantee the SOS will approve it.

Fictitious Business Names

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A corporation doing business in California under a name other than its legal name must file a fictitious business name (FBN) statement with the office of the county clerk (and not the SOS) of either:

• The county where the corporation’s principal place of business in California is located.

• Sacramento County, if the corporation does not have a place of business in California.

(Cal. Bus. & Prof. Code § 17915.) Parties should confirm the procedures and fees for filing and registering the corporation’s FBN statement with each county in which the corporation must file the statement. After filing the FBN statement, the corporation must:

• Within 30 days of filing, publish the FBN statement in a newspaper of general circulation in:

• the county where the FBN statement was filed;

• an adjoining county (if the county of filing has no newspaper of general circulation); or

• Sacramento County, if the LLC has no place of business in California.

• Within 30 days after completion of publication, file an affidavit of publication with the office of the county clerk in the county where the statement was filed.

(Cal. Bus. & Prof. Code § 17917(a), (d).) An LLC may file an FBN statement in other counties (Cal. Bus & Prof Code § 17915). For more information on FBNs, see Fictitious Business Names in California Checklist.

Pre-Incorporation Logistics

After determining the state of incorporation, the type of corporation, whether the corporation will be a C- or S-corporation, and the name of the corporation, the next steps to take include:

Ordering a Minute Book A minute book (sometimes referred to as a corporation kit) is a loose ring binder that acts as a place to store minutes of the board of directors and shareholder meetings, the articles of incorporation, bylaws, share register, and share certificates. The minute book usually comes with a form of articles of incorporation, bylaws, corporate seal, specimen share certificate, and share register. The corporation can replace any of the included forms with its own, however counsel should confirm that any self-drafted forms (as well as any included forms the corporation doesn’t replace) conform to current law. A corporation must keep the following records:

• Bylaws and any amendments.

• Accounting and tax books and records.

• Minutes of all proceedings of shareholders, board of directors, and any board committees.

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• A record of shareholders, including each shareholder’s name, address, and number and class of shares held.

(Cal. Corp. Code §§ 213 and 1500 and see Cal. Prac. Guide Corps. Ch. 6-F §§ 6:495 et seq.) The corporation can maintain its records in electronic or other form if they can be converted into clearly legible tangible f orm (Cal. Corp. Code § 1500). As an alternative to or in conjunction with storing paper versions in an official minute book, the corporation should consider scanning or creating electronic copies of its records and maintaining them in a secure, searchabl e database.

Determining Whether to Use a Service Company to File the Articles of Incorporation For a fee, a service company can help file any document with the SOS on behalf of the corporation. Using a service company can provide quicker turn-around times, advancing of filing fees, experience with filing requirements and procedures, and convenience. While it is not a requirement, many firms and corporations use service companies. These corporations and law firms typically have a relationship or account with a particular service company. If using a service company, call the service company’s representative before filing to determine their fees for handling the filing.

Determining Whether the Filing Needs to be Precleared or Expedited The SOS offers preclearance and expedited filing services for a fee (see Practice Note, Filing Documents with the Secretary of State (CA) and Secretary of State: Preclearance and Expedited Filing Services). For information on current processing times, go to Secretary of State: Current Processing Times. Confirm that the client has authorized any preclearance or expedite charges before ordering. Although there is an extra charge, preclearance and expedited processing may be necessary if the corporation is being formed in connection with a time-sensitive transaction.

Choosing the Initial Agent for Service of Process A California corporation must designate and maintain an agent for service of process in California, which may be either:

• A natural person who resides in California.

• A domestic or foreign corporation that has filed the required certificate with the SOS and otherwise complied with Section 1505 of the California Corporations Code, including being authorized to do business and being in good standing in California (Cal. Corp Code § 1505).

(Cal. Corp Code § 1502(b).)

Choosing the Incorporators If the articles of incorporation do not name the initial directors, the articles of incorporation must be signed by one or more incorporators. An incorporator may be a natural person, partnership, association, or corporation. (Cal. Corp. Code § 200(a), (b).) An attorney often acts as the incorporator, but this is not required, and may not be advisable in some instances, since th e incorporator has responsibility for the corporation until the board of directors has been elected. For further discussion of the role of incorporators, see Standard Document, Organizational Action by Sole Incorporator of a Corporation (CA) and Cal. Prac. Guide Corps. Ch. 3-H §§ 3:418 et seq.

Choosing the Initial Directors

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If the articles of incorporation do not name the initial directors, the incorporators have the initial authority to complete the corporation’s organization, including adopting bylaws and electing directors and officers (Cal. Corp. Code §210). There may be advantages in naming the directors in the articles of incorporation, including avoiding potential delays in the corporation’s business activities or deficiencies in the organizational process. If the directors are not named in the articles of incorporation, the incorporators must elect them before the organizational meeting (see Cal. Prac. Guide Corps. Ch. 4-E § 4:399). For more information on directors, see Standard Document, Bylaws (CA): Drafting Note: Powers; Qualifications.

Choosing the Initial Officers A corporation must have:

• A chairperson of the board or a president or both.

• A secretary.

• A chief financial officer.

(Cal. Corp. Code § 312(a)). A corporation may have other officers as set out in the bylaws or determined by the board of directors. The same person may hold two or more offices unless otherwise provided by the articles of incorporation or bylaws. (Cal. Corp. Code § 312(a).) For example, a corporation may have a treasurer and one or more vice-presidents (see Cal. Prac. Guide Corps. Ch. 4-F §§ 4:429 and 4:430). The directors typically elect officers as one of their first organizational actions at their initial meeting (or written acti on in lieu of a formal meeting). If the articles of incorporation do not name the initial directors, the incorporators have the authority t o elect officers (Cal. Corp. Code § 210).

Confirming the Availability of Signatories Parties should confirm the availability of signatories before appointing them, especially if the corporation is being formed for a specific and imminent purpose. For example, if a corporation is formed to make an acquisition:

• The directors must be available to sign resolutions authorizing the acquisition documents.

• At least one of the officers must be available to sign the acquisition agreement.

Draft Formation and Organizational Documents

In addition to the articles of incorporation, which is the only document that must be filed with the SOS, several other documents are needed to properly form and organize a California corporation. Before drafting these documents, obtain the necessary information, such as the identity of the directors and the agent for service of process in California.

Articles of Incorporation In California, a corporation may file articles of incorporation by using one of the following:

• Form ARTS-GS, Articles of Incorporation of a General Stock Corporation, a fillable form for the formation of a general stock corporation provided by the SOS.

• Form ARTS-CL, Articles of Incorporation of a Close Corporation, a fillable form for the formation of a close corporation provided by the SOS.

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• Form ARTS-PC, Articles of Incorporation of a Professional Corporation, a fillable form for the formation of a professional corporation provided by the SOS.

• A self-drafted form of any of the above that conforms to the Code’s requirements (Cal. Corp. Code § 202).

For self-drafted forms of articles of incorporation, including discussion of drafting considerations, specific requirements (based on the type of corporation) and filing advice, see Standard Documents:

• Articles of Incorporation: General Stock Corporations (CA).

• Articles of Incorporation: Close Corporations (CA).

• Articles of Incorporation: Professional Corporations (CA).

• Articles of Incorporation: Benefit Corporations (CA).

• Articles of Incorporation: Social Purpose Corporations (CA).

The Code specifies both required and optional provisions for the corporation’s articles of incorporation (Cal. Corp. Code §§ 202 and 204). For more information on preparing California articles of incorporation generally, see Cal. Prac. Guide Corps. Ch. 4-A.

Required Provisions The articles of incorporation must include all of the following:

• The name of the corporation (see Name of Corporation).

• The purpose of the corporation, set forth in specific statutory language.

• The name and street address of the corporation’s initial agent for service of process.

• The corporation’s street address and mailing address (if different from the street address).

• The authorized share structure of the corporation (see Cal. Prac. Guide Corps. Ch. 4-A §§ 4:35 et seq.).

(Cal. Corp. Code § 202.)

Optional Provisions The articles of incorporation may contain other provisions not inconsistent with law relating to the management of the business and the conduct of the affairs of the corporation (Cal. Corp. Code § 204(d)). Parties should be cautious on how and to what extent additional terms are included in the articles because they are publicly filed. For a private corporation, the articles typically contain only the required and other basic information while all other provisions are included in the bylaws (see Bylaws). Certain optional provisions, however, are effective only if included in the articles of incorporation. When drafting articles, parties may want to consider adding one or more of these provisions to modify the Code’s statutory defaults:

• The right to levy assessments on the shares or any class of shares.

• Preemptive rights granted to shareholders to subscribe to any or all issues of shares or securities.

• Special qualifications of prospective shareholders.

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• Limiting the corporation’s duration to a specified date.

• Requiring a supermajority vote or quorum for any or all corporate actions (supermajority requirements may be

imposed by statute for certain actions even if not included in the articles of incorporation).

• Limiting or restricting the corporation’s powers or business.

• Granting voting rights to holders of any evidences of indebtedness, issued or to be issued by the corporation.

• Shareholders’ right to determine the consideration for issued shares.

• Requiring shareholder approval or the approval of outstanding shares for any corporate action, when this approval is not otherwise required by the Code.

• Eliminating or limiting director liability for breach of fiduciary duty within certain limits.

• Indemnifying the corporation’s agents (for example, a director).

(Cal. Corp. Code § 204(a).) For a discussion on including optional provisions in the articles of incorporation, see Cal. Prac. Guide Corps. Ch. 4-A §§ 4:50 et seq.

Filing the Articles of Incorporation After the articles of incorporation have been prepared, executed, and acknowledged (acknowledgment is needed for each signature of a director only if directors are named), the original articles of incorporation must be filed with the SOS, accompanied by payment of the applicable fees (Cal. Corp. Code § 200(a)). If a name has been reserved (see Name Reservation), a copy of the name reservation certificate should be included to avoid rejection for an unavailable name. The fee to file the articles of incorporation by mail is $100 (Cal. Gov’t Code § 12186(c)). If filing in person, an additional $15 non-refundable special handling fee is required which must be paid by separate check. Checks or money orders must be made payable to “Secretary of State”. If submitting articles in person in the Sacramento office, fees may also be paid by credit card (Visa or MasterCard). Confirm current fees on the SOS website (see Secretary of State: Business Entities Fee Schedule). For more information on filing the articles of incorporation, including filing and payment methods, filing and additional fee s, expedited filing, and required supporting documents, see Practice Note, Filing Documents with the Secretary of State (CA) and Secretary of State: Corporate Filing Tips.

Statement of Information A new corporation must file a Form SI-550 Statement of Information with the SOS within 90 days after filing its original articles of incorporation and annually thereafter (Cal. Corp. Code §§ 1502(a), (b) and see Secretary of State: Form SI-550). If there has been no change in any of the information contained in the previous complete statement of information, a corporation may instead file a Form SI-550 NC Statement of No Change (Cal. Corp. Code § 1502(c) and see Secretary of State: Form SI-550 NC). The fee to file the initial or an annual statement of information or an annual statement of no change by mail is $25 (which includes a $5 disclosure fee). There is no fee to file (by mail) a statement of information submitted between filing periods to report a change of information. (Cal. Corp. Code § 1502(d) and Cal. Gov’t Code §§ 12186(g), (i) and see Secretary of State: Form SI-550.) If filing in person, an additional $15 non-refundable special handling fee is required which must be paid by separate check. Confirm current fees on the SOS website (see Secretary of State: Business Entities Fee Schedule).

Bylaws Bylaws are the internal governance rules of a corporation. The bylaws may contain any provision, consistent with law and the

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articles of incorporation, for the management of the business and the conduct of the affairs of the corporation (Cal. Corp. Code § 212(b)). Although the Code does not explicitly require a corporation to adopt bylaws, nearly all corporations do, and a corporation mu st keep an original or copy of its bylaws at its principal executive office or principal business office in California (Cal. Corp. Code § 213). A corporation must adopt bylaws if its articles of incorporation do not state the number (or maximum and minimum number) of directors. In this case, the incorporators must adopt bylaws specifying the number (or maximum and minimum number) of directors before the first board meeting. (Cal. Corp. Code § 212(a) and see Cal. Prac. Guide Corps. Ch. 4-D § 4:172.) Bylaws function as regulations among the shareholders, directors, and officers of the corporation. Typical areas covered in t he bylaws include:

• Procedures for meetings of shareholders and directors (including record date, notice, and voting).

• Procedures for the election, removal, and compensation of directors and officers.

• Issuance and transfer of shares of the corporation.

• Granting officers authority to execute agreements on behalf of the corporation.

• Defining the scope of indemnification of directors, officers, employees, and agents (Cal. Corp. Code § 317).

Bylaws may be adopted, amended, or repealed by either:

• The incorporators prior to the election of directors.

• The outstanding shares of the corporation (Cal. Corp. Code § 152).

• The directors, unless restricted by the bylaws or articles and subject to certain statutory exceptions.

(Cal. Corp. Code §§ 210 and 211.) For more information on drafting the bylaws, see Standard Documents, Bylaws (CA) and Cal. Prac. Guide Corps. Ch. 4-D.

Organizational Action

If the articles of incorporation do not name the initial directors, the incorporators may, until the directors are elected, take any action necessary and proper to complete the organization of the corporation, including:

• Adopting bylaws.

• Electing directors and officers.

(Cal. Corp. Code § 210.) The incorporators typically only elect the initial directors and, if necessary, a bylaw establishing the number or minimum and maximum number of authorized directors (if not set forth in the articles). The directors then complete the organization of th e corporation. Actions typically taken by the directors as part of the organizational action include, but are not limited to:

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• Adopting bylaws.

• Electing officers.

• Approving the form of certificate for the corporation’s shares (unless uncertificated).

• Accepting subscriptions for, and issuing shares to, the shareholders.

• Determining the corporation’s fiscal year.

• Authorizing the opening of bank accounts.

• Establishing borrowing authority.

• Establishing officers’ salaries if the directors have elected officers.

• Approving contracts.

• Ratifying an S-corporation election for tax purposes, if applicable (see C- or S-Corporation).

For further discussion of organizational action by directors, see Cal. Prac. Guide Corps. Ch. 4-F. For examples of organizational action taken by written consent, see Standard Documents, Unanimous Written Consent of the Board in Lieu of Organization Meeting (CA) and Organizational Action by Sole Incorporator of a Corporation (CA).

Issuance of Shares

A corporation raises capital by selling and issuing shares. The articles of incorporation set the number, classes, and series of shares and their rights, preferences, privileges, and restrictions or, in certain circumstances, such as the determination of the rights, preferences, privileges, and restrictions of an unissued class of shares, may authorize the board of directors to make the determination (Cal. Corp. Code §§ 202(f), (g)). Consideration for shares can include:

• Money paid.

• Labor performed.

• Property (tangible or intangible) actually received.

• Services actually rendered (but not future services) to or for the benefit of the corporation or in its formation.

• Cancellation of debt or securities.

(Cal. Corp. Code § 409(a)(1).) Each shareholder is entitled to a physical share certificate unless the corporation has adopted an electronic system permissible under the Code (along with the required notice). Each physical share certificate must certify the number of shares and the class or series of shares owned by each shareholder and be signed by both:

• The chairperson or vice-chairperson of the board, the president, or a vice-president.

• The chief financial officer, an assistant treasurer, the secretary, or an assistant secretary.

(Cal. Corp. Code § 416.) For a discussion on the contents of certificates, see Cal. Prac. Guide Corps. Ch. 5-D §§ 5:447 et seq.

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As an alternative to share certificates, a corporation may adopt a system of share issuance, registration and transfer by electronic or other means not involving the physical issuance of share certificates (Cal. Corp. Code § 416(b)). The system must be approved by the Securities and Exchange Commission (SEC) or otherwise be authorized by any statute or in

accordance with Division 8 of the California Commercial Code (Cal. Com. Code §§ 8101 et seq.). The system must also comply with any rules adopted by the Corporations Commissioner (Cal. Corp. Code § 416(b)). The corporation must keep a record of shareholders’ names, addresses, and number and class of shares held (Cal. Corp. Code § 1600(a) and see Ordering a Minute Book). Counsel should consider whether there are any registration or notification requirements under applicable federal and state securities laws (for example, the Securities Act of 1933, as amended (15 U.S.C. §§ 77a et seq.) and the California

Corporate Securities Law of 1968 (Cal. Corp. Code §§ 25100 et seq.)). Unless there is preemption by federal law, a person generally cannot legally offer or sell any security in California unless the transaction is qualified or exempt (Cal. Corp. Code §§ 25102 and 25110). For a discussion of California securities laws requirements generally, see Cal. Prac. Guide Corps. Ch. 5-C. Counsel should also review the securities statutes and regulations in any state besides California where the shares will be offered or sold and comply with all applicable requirements. Before authorizing another class of shares beyond common shares, the parties should confirm that the corporation will be classified as a C-corporation for federal tax purposes. To qualify for S-corporation status, a corporation may not have more than one class of shares except for classes distinguishable only by voting rights and not by rights to distributions or allocations of profit and loss (IRC §§ 1361(b)(1)(D), (c)(4) and see C- or S-Corporation).

Shareholder Agreements

Although not required, shareholders sometimes enter into agreements with each other at the time of formation to anticipate and provide for the resolution of matters that may be of later concern or disruption, including:

• Control and management of the corporation.

• Initial and future capital contributions.

• Ownership and voting rights or obligations.

• Supermajority voting requirements for specified corporate actions.

• Restrictions on the transfer of shares, such as pre-emptive rights or rights of first refusal.

• Resolution of disputes and deadlock.

• Preventing a shareholder from competing with the corporation, soliciting customers, or revealing trade secrets if the shareholder sells its interest.

Two or more shareholders may effectively pool their votes by entering into a written agreement providing that their shares will be voted on certain matters as provided in the agreement, as agreed by the parties, or as determined by an agreed-upon procedure. The agreement may be enforced by specific performance. (Cal. Corp. Code § 706(a) and see Cal. Prac. Guide

Corps. Ch. 3-B § 3:159.3.) For resources to assist in preparing and evaluating agreements among shareholders, see Stockholders (Shareholders) Agreements Toolkit. For an example of a shareholder agreement in a closely held corporation that restricts the transfer of shares to third parties, see Standard Document, Buy-Sell Agreement (General Form): Corporations.

Close Corporations Shareholders in a statutory close corporation may enter into a shareholders’ agreement that sets out the matters on which the

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shareholders (and not the board of directors) will exercise management control (Cal. Corp. Code § 300(b) and see Cal. Prac. Guide Corps. Ch. 3-D §§ 3:243 and 3:248 et seq.). Subject to certain statutory exceptions, a shareholders’ agreement may govern any of a statutory close corporation’s affairs. Shareholders exercising management control under a shareholders’ agreement are subject to the liability that would otherwise be imposed on directors for performing (or failing to perform) managerial acts. (Cal. Corp. Code § 300(b) to (d).) Shareholders in a statutory close corporation sometimes enter into buy-sell or buy-out agreements, intended to preserve ownership continuity, provide for orderly succession of ownership, and avoid disputes. These agreements may:

• Restrict a transfer of shares to unrelated third parties or establish procedures for a transfer (for example, giving other shareholders the opportunity to buy the shares).

• Provide a manner for resolving major events, such as a shareholder’s death or divorce.

For a discussion of buy-out agreements generally, see Cal. Prac. Guide Corps. Ch. 3-C. For an example of an agreement that restricts the transfer of shares to third parties, see Standard Document, Buy-Sell Agreement: Corporations (CA).

Obtaining Signatures and Delivering Documents

It is crucial to obtain all necessary signatures and date the documents so that they are legally binding. Copies of all documents should be filed in the minute book of the corporation so that the corporation can prove that it observed all necessary formalities (see Ordering a Minute Book). After the articles of incorporation are filed, counsel must:

• Verify that the organizational actions of the corporation have been taken by either the incorporators or the board of directors by a unanimous written consent or at a formal meeting. Once these documents are complete, file them in the corporation’s minute book.

• Arrange for the full execution of any subscription agreements and share certificates. Once these documents are complete, deliver the originals to the shareholders and file a copy of each in the corporation’s minute book. All share issuances should be recorded in the share ledger.

• Arrange for the full execution of any shareholder agreements. Once these documents are complete, deliver the originals to the shareholders and file a copy of each in the corporation’s minute book.

Post-Incorporation Logistics

Once the corporation is formed and the directors and officers are elected and appointed, there are additional steps to complete before the corporation can begin doing business:

• File for any necessary foreign qualifications. If the corporation will conduct business in other states, it must be properly qualified. While specific requirements of each state vary, qualification typically involves:

• checking the name availability of the corporation in that state;

• preparing and filing any necessary document (often called a certificate of authority), which often contains similar information to the articles of incorporation and includes a submission to service of process in that state; and

• paying fees.

• Apply for an Employer Identification Number (EIN) with the Internal Revenue Service (IRS). An EIN is necessary for

tax filing and reporting purposes and to identify the corporation. It is often required before a corporation can transact any

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business or even open a bank account. A corporation can apply for an EIN on the Internal Revenue Service’s website (see IRS: Apply for an Employer Identification Number (EIN) Online). There is no application fee.

• File for any necessary intellectual property protection, including:

• a state trademark with the SOS (see Secretary of State: Trademarks and Service Marks);

• a federal patent or trademark with the US Patent and Trademark Office (see United States Patent and Trademark

Office); and

• a federal copyright with the US Copyright Office (see United States Copyright Office).

• Apply for any required licenses, permits, or certifications, including:

• federal or state business or occupational licenses and permits necessary for the operation of the business; and

• local permits needed for the operation of the business, such as building, health, food and beverage, and zoning.

For an overview of employment laws and human resources issues that may apply to new and expanding California companies, see Practice Note, California Employment Law Issues for Startups, Entrepreneurs, and Growing Businesses: Overview. For an overview of the types of equity compensation commonly used by new companies for employees, see Practice Note, Choosing the Right Type of Equity Compensation for Startup Company Employees.

Tax Credits and Incentives

Determine if the corporation is eligible for any beneficial tax credits or incentives, such as:

• California Competes Tax Credit.

• California Motion Picture and Television Production Credit.

• California Research Credit.

• Economic Development Area Credits.

• New Employment Credit.

Further Assistance

A corporation can seek advice or assistance from various local, state, or federal programs to help the corporation’s business, including:

• US Small Business Administration (SBA). Programs and information that the SBA offers include the following:

• 8(a) Business Development Program, an SBA program designed to help small, disadvantaged businesses;

• Historically Underutilized Business Zone (HUBZone) Program, a program designed to help small businesses in urban and rural communities gain access to federal procurement opportunities;

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• Women-Owned Small Businesses (WOSB) Federal Contract Program, a program designed to provide greater access to federal contracting opportunities for WOSBs and economically-disadvantaged women-owned small businesses;

• Service-Disabled Veteran-Owned Small Business Concern (SDVOSBC) Procurement Program, a program designed to provide SDVOSBCs with exclusive competition to federal procurement opportunities; and

• SBA California State Local Assistance Resources.

• SCORE, a non-profit association for the benefit of entrepreneurs and small businesses (SCORE).

• Minority Business Development Agency (MBDA). (MBDA is a part of the US Department of Commerce).

• California Governor’s Office of Business and Economic Development (GO-Biz). (Go-Biz is a point of contact for

economic development and job creation efforts offering a range of services to business owners).

• State of California Employment Development Department (EDD). (EDD provides employer assistance for workforce

recruitment and training.)

• Governor’s Office of Business and Economic Development provides information relating to California permits.

• California Division of Workers’ Compensation and the California Employment Development Department contain information relating to being an employer in California.

• Employment Training Panel (ETP). (ETP funds the cost of vocational training.)

• Chambers of Commerce:

• national: US Chamber of Commerce;

• state: California Chamber of Commerce; and

• local.