By Richard Harroch
Forming a California corporation provides entrepreneurs with a number of benefits. If properly operated, a corporation will protect the shareholders of the corporation from the debts and liabilities of the business. The corporation can raise capital from angel investors, venture capital firms, and other investors. Incorporation can provide a business with credibility and brand recognition, and can facilitate a future sale of the company. Corporations can also have shares that are easily transferable.
A number of key steps should be taken to properly form and operate a California corporation. California corporations can be formed through startup lawyers, through incorporation services (such as ZenBusiness, CorpNet, or MyCorporation), or directly by an entrepreneur.
This article provides a comprehensive guide to forming a California corporation.
Step #1: Name your California corporation
Arriving at a good name for your California corporation is not easy. When you are starting a business, selecting the right name for your startup can have a significant impact on your business success. The wrong name could result in insurmountable legal and business hurdles.
Here are some basic naming tips to follow:
- Check if your proposed name is available by doing a name eligibility search on the California Secretary of State’s website. California law specifically states that “the Secretary of State shall not file a document or grant a name reservation that includes a proposed corporate name that is the same as or deceptively similar to an existing corporate name.”
- Check to make sure your name hasn’t been federally trademarked by someone else by searching the U.S. Patent and Trademark Office trademark database.
- Conduct a comprehensive internet search on the name to make sure you aren’t using the name of an existing business.
- California law requires that you include some variation of “Incorporated,” “Inc.,” “Corporation,” “Corp.” or “Limited” as part of the name. This is typically done, for example, by naming the company “American Glass & Metals, Inc.”
- Don’t use names that can be misleading to the public (such as implying affiliation with a government agency or entity).
- Certain words in the name are restricted without having a particular license, such as for banks, insurers, and credit unions.
- Consider filing a trademark application with the USPTO or the state to protect the name.
- Avoid hard-to-spell names.
- See if the domain name associated with the business name is available (with the “.com” variation being preferred).
- Don’t pick a name that could be limiting as your business grows. For example, Jeff Bezos made a good decision in picking “Amazon” as a name rather than “OnlineBooks.”
If you plan to operate under a different name than your registered corporate name you may need to register a “DBA” or “doing business as.”
For more tips on naming your corporation, see 10 Tips for Naming Your Startup Business.
Step #2: Choose a California registered agent
When your California corporation is formed, it must have a “registered agent,” known as an “agent for service of process.” The registered agent is a person or business entity authorized to do business in California who receives official legal and tax correspondence on behalf of the corporation.
The registered agent can be an officer of the company, a shareholder, a director, another person who resides in California, or a dedicated registered agent service company. The registered agent must have a physical street address in California (a P.O. Box will not work); their address is listed in the public records via the California Secretary of State’s website. Registered agents must be available during normal work hours.
Many of the online incorporation services (ZenBusiness.com, CorpNet, MyCorporation, etc.) will provide registered agent services for a modest annual fee, connected with their incorporation services. Using an outside registered agent can protect your privacy as the registered agent’s address is listed in the public records, and not your physical address. Also, some people establish companies outside of the state they live in and will use a registered agent to provide an address for receiving legal documentation in California.
Step #3: Create and file the Articles of Incorporation
After you select the corporate name and pick a Registered agent, you must file the official document creating the corporation with the California Secretary of State. This can be filed by you, your corporate lawyer or with the help of an online incorporation service. This document is called the Articles of Incorporation. California Form ART-GS is the form typically used for filing when only one class of shares is involved, although any format may be used, provided it meets the statutory requirements.
The Articles of Incorporation are typically short—two to three pages long. Key sections are:
- The corporate name. This section of the Articles identifies the formal name of the corporation.
- Address. The complete street address, city, state, and zip code of the corporation’s initial address. This must be a physical address and not a P.O. Box.
- The purpose of the corporation. This is the typical purpose clause: “The purpose of the corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code.”
- The authorized capital. This section must set forth the total number of shares that the corporation can issue and the different classes of stock. Early on, you typically have only one class of common stock, but sometimes you can issue both common stock and preferred stock. This section should authorize a sufficient number of shares to cover the founder’s shares plus shares that may be issued to future employees or investors. Think about authorizing 10,000,000 or more shares.
- Name and address of registered agent. The corporation is required to designate the name and address of a registered agent for service of process in the state. See Step #2 (above): “Choosing a California registered agent.”
- Other required provisions. Some provisions, such as preemptive right to purchase future shares, must also be contained in the Articles to be effective.
- Signature. The Articles must be signed by each incorporator (although there is typically only one incorporator).
The filing fee for California Articles of Incorporation is $100, with extra fees for expedited service.
Sample forms of Articles of Incorporation can be found in the Business Forms and Agreements Center of AllBusiness.com.
Step #4: Appoint the corporation’s board of directors
Every California corporation must have a board of directors, which is responsible for managing and overseeing the business of the corporation generally. As part of the corporate formation, initial directors are typically appointed by the incorporator through a simple Statement of Incorporator.
There is not a minimum age, experience/background, or required residency to be a director of a California corporation.
Corporations with one shareholder must have at least one director. Corporations with two shareholders must have at least two directors. Corporations with three or more shareholders must have at least three directors.
New or replacement directors are voted on by the shareholders of the corporation.
Step #5: Adopt the organizational resolutions of the board of directors
As part of the corporate formation process, the directors will typically adopt organizational board resolutions in a meeting in accordance with the corporate bylaws, or by a unanimous written consent.
The organizational resolutions can include some or all of the following authorizations:
- Appointing officers (typically the CEO, CFO, and Corporate Secretary)
- Issuing stock
- Adopting a stock option plan
- Electing S corporation status, if appropriate
- Ratifying opening corporate bank accounts and signature authorizations (banks will often have the form of resolutions they want to see)
- Ratifying any key early contracts
- Election of fiscal year
- Reimbursement of incorporation expenses incurred
- Authorization of Indemnification Agreements with officers and directors
- Adoption of bylaws
Step #6: Create and adopt California corporate bylaws
The bylaws of a corporation contain the rules and procedures that govern the rights and powers of shareholders, directors, and officers. Most lawyers and incorporation services have a prepared “standard” set of template bylaws that may be modified to meet your company’s specific requirements.
The bylaws are typically adopted by the board of directors in the organizational meeting, or with written unanimous consent in place of the organizational meeting.
The bylaws typically cover the following:
- Size of the board of directors
- When and how board meetings are called (including notice)
- When and how shareholder meetings are called (including notice)
- Duties and responsibilities of directors and officers
- Procedures for exercising voting rights
- Regulation of the transfer of corporate stock
- Indemnification obligation for officers and directors (protection from lawsuits and claims against the officers or directors)
- The company’s fiscal year
- General corporate matters
Bylaws generally may be adopted, amended, or repealed by the board of directors or by a vote of the shareholders, and the bylaws may limit the board’s powers in this respect.
Step #7: Issue shares of stock
Owners of a corporation are “shareholders” and are issued stock evidencing their ownership interest in the corporation. The board of directors needs to authorize the sale and set a price for each share of stock. Whenever stock is sold, federal and state securities laws may be applicable. But for many small companies with small stock issuances to founders, a “private placement” exemption from the registration requirements of the securities laws will likely be available. In California, you may be required to file a notice with the California authorities pursuant to Section 25102(f) of the California Corporations Code, within 15 days after the issuance of stock. You can file this notice online.
If you are selling stock to investors, the laws become more complicated and a startup/securities lawyer should be consulted.
Shareholders can provide cash, property, or services in payment of their stock.
Make sure you have a stock ledger which records each stock certificate issued, the date, the certificate number, and the consideration received by the corporation.
Step #8: Consider having your corporation treated as an S Corporation
S corporations are corporations that elect to “pass through” their federal income, losses, deductions, and credits to their shareholders. This can be advantageous to the shareholders of a company in the early years where there may be losses in the business; shareholders will then be able to use those losses on their individual tax returns. Also, if the corporation makes a profit, there will only be a tax at the shareholder level, avoiding the double tax of regular C corporations that earn profits and then make distributions to their shareholders.
To be eligible to elect S corporation status, the following key rules apply:
- The corporation can have no more than 100 shareholders.
- The shareholders must generally be individuals (exceptions are made for certain tax-exempt organizations, trusts, and estates, but corporations and partnerships generally can not be shareholders).
- There can only be one class of stock in the corporation (preferred stock and common stock is not allowed).
- Shareholders must be U.S. citizens or residents.
The S corporation election must generally be made by filing with the IRS by the 15th day of the third month the election is intended to be effective, or at any time during the year immediately preceding the tax year.
In California, S corporations pay a franchise tax of 1.5% of net income to the state of California, subject to a minimum of $800.
S corporation election is made through IRS Form 2553, found on the IRS website here.
Step #9: Determine which permits, licenses, or registrations you will need to form your California corporation
Depending on the nature of the business, you may need the following permits, licenses, or regulations:
- Permits need for regulated businesses (aviation, agriculture, bars, etc.)
- Sales tax license or permit
- Home-based business permits
- City and county business permits or licenses
- Zoning permit
- Seller’s permit
- Health department permits (such as for a restaurant)
- Federal and state tax/employer IDs
Also, check out the CalGold website, which assists California businesses in finding appropriate permit information and contact information for the various California agencies that administer and issue these permits. Depending on your business, there may be permits or licenses necessary on the federal level as well. Check out the SBA site here for guidance on federal permits and licenses.
Step #10: File a Statement of Information with the California Secretary of State
Within 90 days after filing the Articles of Incorporation, a corporation must file a “Statement of Information” with the California Secretary of State and pay a filing fee. The form can be found online here. The Statement provides basic information about the corporation.
For domestic stock and agricultural corporations, the Statement of Information must be filed yearly.
Step #11: Pay attention to your business contracts
Business contracts are legally binding written agreements between two or more parties. They are an important part of doing business and such agreements need to be created and/or negotiated carefully.
While smaller businesses will often conduct business based on informal handshake agreements or unspoken understandings, the more that is at stake, the more essential it is to have a signed contract. A contract serves as the rules that must be followed by both parties. It presents each party with the opportunity to:
- Describe all obligations they are expected to fulfill.
- Describe all obligations they expect the other party (or parties) to fulfill.
- Limit any liabilities.
- Set parameters, such as a time frame, in which the terms of the contract will be met.
- Set terms of a sale, lease, or rental.
- Establish payment terms.
- Clearly establish all of the risks and responsibilities of the parties.
A contract is, in essence, a written meeting of the minds. While it is typically drawn up by one party and favors the needs and requirements of that party, protecting them from most (if not all) liabilities, prior to signing it should be thought of as a work in progress that changes and grows as each party contributes to it. After signing, it becomes an official document. “Consideration,” whether it is monetary or a promise to do work/provide a service by a specified date, is at the root of a contract.
The term “standard contract” is more myth than reality, and too often people simply sign on the dotted line without reading or negotiating the terms of a contract. A startup has to make sure it is comfortable with all of the terms of the contract, and depending on the deal dynamics, almost any term is negotiable.
Consideration, compensation, ownership rights, liability, and risk are all areas that need to be worded carefully. Anyone starting a business should seek help from a qualified attorney who is experienced in contracts to make sure each of these areas are covered in a clear manner.
The contract itself should stipulate how it shall be enforced and what actions can be taken if one party fails to meet their obligations. It is often to the benefit of smaller businesses to have a confidential binding arbitration clause to resolve any disputes.
The key contracts that a startup should have as its own form of “standard contract” (drafted in the startup’s favor) include:
- Sales or service agreement
- License agreement
- Offer letter to employees
- Consulting agreement with any independent contractors (you want to make sure that you will own the intellectual property rights for anything they develop for your business)
- Confidentiality and Invention Assignment Agreement for employees and independent contractors
- Non-disclosure agreement
Step #12: Obtain a tax ID when starting a California corporation
In most instances, you will need to get a tax ID from the IRS for your company. This is also known as an “Employer Identification Number” (EIN), and it’s similar to a Social Security number, but for businesses. Banks will ask for your EIN when you open a company bank account and you need it when filing tax returns.
You can get an EIN online through the IRS website. There is no fee for obtaining the EIN from the IRS.
Step #13: Set up a good accounting and bookkeeping system
You will need to set up a bookkeeping/accounting system to keep track of your company’s finances: income, expenses, capital expenditures, EBITDA, profit and loss, etc. This is important in order to understand your business’s cash flow situation and also for tax-filing purposes.
There are a number of online software solutions that can be helpful in this regard, such as QuickBooks, Zoho, FreshBooks, and Xero.
Step #14: Follow corporate formalities to protect against personal liability
Many business owners are under the mistaken impression that they are completely protected from personal liability by filing Articles of Incorporation for a California corporation. This is not true. The mere process of incorporating does not completely protect business owners. To lessen the likelihood of such personal or shareholder liability, you should make sure to adhere to certain procedures:
- Always use the corporate name. The name of the corporation should be used in full, including “Inc.” or “Corp.” on all contracts, invoices, or documents used by the corporation. This clearly indicates the existence of the corporation as a separate entity.
- Always use proper signature. This means that you will sign on behalf of the corporation, using the name of the corporation and your title. You should typically use the following format when signing contracts on behalf of the corporation:
[Your name—authorized signing officer and corporate title]
- Follow all corporate formalities. This includes following bylaws, issuing stock properly, holding meetings of the board of directors, recording the meeting minutes, and following other corporate formalities.
- Make sure to keep funds separate. Corporate funds and the funds of individual shareholders should not be in the same accounts or combined for any reason.
- All transactions made by the corporation should be clearly separate from any individual transactions. Essentially, by never blurring the line between individual shareholders, officers or the board of directors, and the company (which stands as a separate entity), you run less risk of any personal liabilities for the debts of the business.
Step #15: Be sure to properly insure your startup
If you are going to go through the time and effort to start a business, you need to protect it by obtaining appropriate insurance coverage.
Your first order of business should be to determine your specific insurance needs based on the nature of your business. Ask yourself what risks must be covered and how much coverage will be sufficient. Then find and evaluate insurance providers or insurance brokers to determine which companies handle the types of coverage that suit your needs.
While shopping for insurance, you will want answers to these types of key questions:
- What are the deductibles?
- Are the coverage limits high enough?
- What items or occurrences are excluded from coverage?
- Are there any gaps in the coverage?
Here is a list of the types of insurance that may be appropriate for your business:
- General liability insurance
- Product liability insurance
- Professional liability insurance
- Property insurance
- Worker’s compensation insurance (see the California Department of Industrial Relations website for more info)
- D&O (directors & officers) insurance
- Health insurance for employees
- Business interruption insurance
- Commercial auto insurance
- Data breach/cybersecurity insurance
- Key person life insurance
- Unemployment insurance (see the California EDD website for more info)
Additional information on forming a California corporation
Copyright © by Richard D. Harroch. All Rights Reserved.
About the Author
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a venture capital fund in the San Francisco area. See all his articles and full bio on AllBusiness.com.
This article was originally published on AllBusiness.com.