California Corporations: An Overview
Many people start a California corporation without understanding the documents involved and their implications. This guide will review key documents required and/or used in the formation of a California corporation and a brief summary of their typical contents.
Articles of Incorporation
Articles of Incorporation are the charter document for the corporation. The Articles are filed with the Secretary of State, and upon their filing, the corporation is in legal existence. The Articles of Incorporation contain the name of the corporation, the general purpose of the corporation (this is statutory language that cannot be changed), identification of the original agent for service of process, the type of stock (i.e., common and/or preferred) and any rights or restrictions associated with the stock, and the number of authorized shares. The Articles may also contain other provisions, such as providing for limiting the liability of the Board of Directors, and authorizing the corporation to indemnify its agents.
Agent for Service of Process
Under California law, each corporation must maintain an agent for service of process, who can either be an individual, or a corporation whose sole purpose is to act as agent for other corporations. The corporation can change its agent for process of process at any time by filing an amended Statement of Information (discussed below). As a courtesy to our corporate clients, Mayfield Bustarde, LLP serves as agent for service of process for no additional fee.
Type of Stock
There must be at least one type of stock, normally common. However, there can be more than one type of stock, such as common and preferred, with different rights attached to one of the types of stock. For example, if a corporation also authorizes preferred stock, that stock would have certain preferential rights, which may include priority to receipt of dividends, priority to distributions of money and/or assets when the corporation is dissolved, and the right to convert the stock into common stock. If there are different rights associated with any class of stock, those rights must be identified in the Articles of Incorporation.
Authorized Shares of Stock
The Articles of Incorporation must also identify the total number of authorized shares the corporation may issue. This can be any number (although if the corporation is going to do business in other states, you should consult with Mayfield Bustarde, LLP as some states base their annual fees on the number of authorized shares), but is usually given a round number such as 1,000, 1,000,000 or 10,000,000. The corporation does not have to, nor should it, issue all of these shares immediately. It only has to issue some of the stock, and can retain the remaining authorized shares to issue to future shareholders, stock options, or to the current shareholders if they make additional capitalization at a later time.
The Bylaws are the governing document for the corporate operations. It contains provisions concerning the Board of Directors, the Shareholders, and the Books and Records of the corporation.
Board of Directors
The Bylaws contain provisions concerning the number of persons that can sit on the Board of Directors, how to remove a director, what happens if there is a vacancy on the Board of Directors. It also addresses the date for the annual meeting for the Board of Directors, and how to notice additional meetings.
The Bylaws also address the date for the annual meeting of the shareholders, and how to schedule and give notice for other meetings. It addresses how to determine if there are enough shareholders present to hold a meeting (called a quorum), who can vote at meetings, and the person who shall be in charge of running shareholder meetings.
The Bylaws also identify the officers that can be appointed, their duties, what happens if there is a vacancy in any office, and the order the officers are authorized to act if the President is absent.
Books and Records
The Bylaws also discuss who can inspect the books and records of the corporation, the annual report of the corporation, and, how the Bylaws can be amended.
Shortly after the formation of the corporation, the incorporators, initial shareholders and initial members of the Board of Directors will hold a meeting called an Organizational Meeting. At this meeting, these founders will adopt Bylaws, appoint Directors, issue shares, and vote upon other relevant resolutions to start the corporation. Minutes (which are notes of what happened in the meeting) are part of the formation documents and are kept with the corporate records.
After the Organizational Meeting, minutes from any meeting of the Board of Directors or Shareholders must be prepared and kept with the corporate documents.
At the Organizational Meeting, the corporation will issue stock. In order for the corporation to be validly formed, the corporation must issue stock to at least one person or entity for valid consideration. Valid consideration includes cash, assets, or cancellation of debt. The corporation cannot issue stock for future services. The corporation will issue a Stock Certificate to each shareholder, which identifies the shareholder’s name, the number of shares issued, and any limitations on the sale of the stock. Also, the corporation will often require the shareholder to sign an Investment Representations Letter, in which the investor represents to the corporation that he or she is purchasing the stock for their own account, that the investor acknowledges that purchasing the stock is a risk and that he or she may never see a return on their investment. This Investment Representations Letter is required for certain State and Federal exemptions from registering the stock as securities. In addition, the corporation will also prepare a Stock Ledger, which lists each shareholder, their address, the number of their Stock Certificate, the number of shares issued, and the amount paid for the shares. The Stock Ledger will also track any subsequent sales of the shares.
Statement of Information
The Statement of Information is a form that identifies the key persons in charge of the corporation. Specifically, it identifies the corporation’s address, the names and addresses of all Directors and of the President/CEO, Secretary and Treasurer/Chief Financial Officer. It also contains a general description of the business and the name and address of the agent for service of process. This form must be filed within 90 days after the Articles of Incorporation are filed. Thereafter, the Secretary of State will send the form directly to the corporation for filing. This form must be filed once a year with the Secretary of State.
In small corporations, it is highly recommended that the initial shareholders enter into a Buy-Sell Agreement. A Buy-Sell Agreement is a contract between shareholders which governs the sale of their stock. It is normally used a way to control who can become a shareholder of the company. In this Agreement, certain “triggering” events are identified that would result in a buy-out of a shareholders stock. The most common triggering event is the death of the shareholder. Upon the death of a shareholder who is a party to the Buy-Sell Agreement, the other shareholders will have the right to purchase the deceased shareholder’s shares. This Agreement may be funded by life insurance, which will pay the cost to buy the deceased shareholder’s shares. Other triggering events that may be found in a Buy-Sell Agreement include, attempts to sale to a third party, termination of employment and conviction of a crime.
Other documents are prepared in conjunction with the formation of the corporation, including an EIN application (to obtain an EIN number from the IRS so the corporation can open its own bank account), any notices and/or registrations filed with the SEC and/or California Department of Corporations, and S-Corporation Election prepared by the corporation’s CPA, if applicable.
In addition, other Agreements may be prepared in conjunction with the starting up of a new business, including Stock Option Plans, Employment Agreements, and Consulting or Independent Contractor Agreements.