Free Articles of Incorporation for California

The Articles of Incorporation typically define the basic structure of the corporation. The "bylaws" are often used to further define this structure, and can contain any provisions not inconsistent with state law or the Articles, relating to the business of the corporation, the conduct of its affairs, and the rights and powers of the shareholders, directors, officers and employees.

The bylaws for a California corporation must state the number of directors or maximum or minimum number (with the exact number to be set by the board or shareholders). If the bylaws state a range of directors, the maximum must be no more than twice the minimum minus one. The bylaws should be maintained at the principal business office of the corporation at all times, and if no such office is located in California, then the corporation must provide a copy of the bylaws upon request to any shareholder.

California law allows the Articles to include any provision that can be included in the bylaws. Therefore, theoretically, a corporation could be set up without bylaws by placing all of the desired provisions in the Articles. However, experienced corporate attorneys advise against doing so because any change to the Articles would require filing the amended Articles with the California Secretary of State before they would become effective. Because bylaws are not filed with the Secretary of State, amending them is an internal process generally governed by the Articles and California law.

Changes to the Articles is typically a three step process: board approval, shareholder approval, and Filing Articles of Amendment with the California Secretary of State. The changes are effective only upon filing with the Secretary of State. If a corporation has more than one class of stock, certain changes that affect the rights of a particular class require the approval of the shares in that class under California law, even if the Articles do not require it. Because the variety of possible changes to a corporation�s Articles is virtually limitless, and some changes have a different approval process from others, we recommend that you consult with an experienced corporate attorney before making any changes to your Articles.

Changes to the bylaws can usually be made by the directors (if given that authority when the bylaws are originally adopted by the incorporators or the initial directors), subject to concurrent power by the shareholders. In larger corporations, that is why the most critical provisions (such as voting and dividend rights) are placed in the Articles so that the directors are not able to affect certain shareholder rights without shareholder approval.

The identity of the registered agent for service of process can be changed by a resolution of the directors and the notification to the Secretary of State.

A Board of Directors can be "classified" or divided into different classes. Choosing a classified board allows you to set different terms of office so that one class of directors expires each year (after the initial shareholder's meeting). The use of this method provides continuity on the board because only one-half or one-third of the board may be replaced at any one time.

California law requires that if the board of directors is divided into two classes, the authorized number of directors must be at least six, and half of the directors (or as close an approximation as possible) shall be elected at each annual meeting of shareholders. If the board of directors is divided into three classes, the authorized number of directors must be at least nine and one third of the directors (or as close an approximation as possible) shall be elected at each annual meeting of shareholders.

Note: a classified board is not necessary or desirable for most start up companies.

Some states, including California, offer corporations the option of electing to be organized as a "close corporation." In California, a close corporation�s Articles must state "This corporation is a close corporation," and must expressly limit the number of shareholders to 35 or less. If the corporation qualifies and makes such an election, it is allowed to operate under relaxed rules and less formal management by the shareholders instead of the directors and officers. In such event, the shareholders involved in management of the corporation may have liability for managerial decisions.

Few corporations actually make such an election, for various reasons, and an informed decision to make such an election should only be carried out after consultation with an experienced corporate attorney.

California law allows you to choose any name that is not likely to mislead the public and is not already in use. To be clear that the entity is a corporation, it is advisable to choose a name that includes one of the following words (or abbreviations):

• Company
  
• Co.
  
• Corporation
  
• Corp.
  
• Incorporated
  
• Inc.
  
• Limited
  
• Ltd.

• Association (Assoc.)
  
• Club
  
• Foundation
  
• Fund
  
• Institute
  
• Society
  
• Union
  
• Syndicate

The second requirement is that the name chosen must be distinguishable from any other corporate name which is already on file in California, including out-of-state corporations registered in California as �foreign� corporations and names that have been temporarily reserved by persons intending to incorporate using that name. Whether a name is "distinguishable" lies within the discretion of the Secretary of State. For example, "Acme, Inc." is likely not sufficiently distinguishable from "Acme Corp." However, the Secretary is likely to allow "Smith, Inc." as well as "Smythe, Inc.," even though the two sound identical. It is possible to adopt a name that is substantially the same as an existing corporation, upon proof of consent by such corporation and a finding by the Secretary of State that under the circumstances the public is not likely to be misled.

Before proceeding with the incorporation steps, it is advisable to check with the California Secretary of State to verify that the chosen name for the new corporation is available. A preliminary check of the availability of a corporate name can be made by mailing a name availability inquiry letter (available at the website of the Secretary of State) to the Secretary of State's office in Sacramento. Checking the availability of a corporate name does not reserve the name and has no binding effect on the Secretary of State, nor does it confer any rights to a name.

A request to reserve a corporate name can be made over-the-county at any Secretary of State's office or can be addressed in writing to the Sacramento office. Fees and instructions for reserving a corporate name are included on the Name Reservation Request form available at the website of the Secretary of State. A name reservation is good for 60 days and may not be renewed.

The Articles of Incorporation or the bylaws may specify whether the corporation will have a "corporate seal." Most new corporations choose NOT to have a corporate seal in order to avoid the requirement that such a seal imprint all official corporate documents. For example, the seal can be misplaced, stolen or it may be inconvenient to obtain when it is otherwise needed. Also, in California the failure to affix a seal does not affect the validity of any corporate instrument.

A corporation is a separate legal entity owned by one or more shareholders, and the shareholders have "limited liability." The shareholders elect directors who have overall responsibility for the management of the corporation. The directors elect officers who carry out the wishes of the directors. Thus, a corporation is more complex than either a sole proprietorship or a partnership. However, some of this complexity can be simplified in many small companies by having the shareholders serve as both directors and officers.

1. Organizational Formalities. Organizational formalities include such items as: Articles of incorporation, organizational minutes (or consent), bylaws, stock certificates, federal employer identification number, and minutes and annual reports. For details on these items, see Organizational Formalities.

2. Limited Liability. The owners of the corporation (the shareholders) enjoy "limited liability," that is, the shareholders are only liable for the debts and expenses of the corporation up to the amount of their respective investments in the corporation's stock. However, some state laws may impose liability on the shareholders for unpaid wages in small corporations. Additionally, creditors frequently require the majority shareholder(s) to guarantee the debts of the small corporation or co-sign its notes in their individual capacity, or pledge their personal assets as security for the corporation's loans.

3. Income Taxation. The income and expenses of a corporation are reported on a separate tax form (Form 1120). Unlike the other forms of business entities, the corporation then pays its own taxes on its net income, instead of allocating the income to the owners. (However, alternative tax treatment is available if a "Subchapter S" election is made.)

4. Fringe Benefits. Generally, corporations have the most flexibility in deducting the costs of providing fringe benefits to employees, which is especially attractive for employees who are also officers and shareholders.

5. Double Taxation. shareholders can authorize the payment of dividends to themselves as a means of withdrawing accumulated profits from the corporation. The payment of dividends results in taxable income to the recipient shareholder, even though the corporation already paid tax on that income. This "double taxation" significantly reduces the "after tax" dollars for the owners. However, this double-taxation consequence is easily avoided in closely-held corporations because the shareholders can simply pay themselves greater wages or bonuses (subject to reasonableness) which are deductible by the corporation (taxable to the shareholder) and therefore a means of "distributing" the corporate profits which are taxed only once.

6. Use of the Regular Corporation. Corporations are formed to gain "limited liability," and in some cases, gain an advantage in deducting fringe benefits.

The Articles can include a provision which limits or eliminates the directors' personal liability to the corporation or its shareholders, for breaching certain of their duties to the corporation and its shareholders. Although in small companies the directors are often the same persons as the shareholders, officers and/or employees, this provision is often included in the Articles so that if and when there are "outside" directors, those individuals enjoy some protection against being sued personally for taking, or failing to take, certain actions. Without this protection, outside directors may be hesitant to serve on a company�s board.

The Articles and bylaws can also provide that the corporation will indemnify (pay attorney fees and, if the person is found liable, the judgment amount) the directors, officers, employees and agents from lawsuits brought against those individuals in connection with their services to the corporation. However, under California law there are limits to when a person may be indemnified, such as when the person acted in bad faith, recklessly, or in a self-dealing transaction, or when a court disapproves of indemnification.

Corporations may also obtain insurance covering their agents� liability separate from the corporation�s power to indemnify.

After the corporation is formed and is operating, the shareholders elect the directors of the corporation, who are generally responsible for overseeing the affairs of the corporation. The directors, in turn, typically appoint officers -- the president, one or more vice presidents, the secretary and the treasurer -- to carry out the day-to-day tasks and implement the strategies established by the directors.

Because the function of the incorporator typically ends once the corporation is operating, the "initial directors" are sometimes named in the Articles so that there is a continuous provision of authority. The initial directors serve until the first annual shareholders meeting, at which time "regular directors" are elected. Some states require that the initial directors be named in the Articles. In California and some other states, the initial directors need not be named until the "Organizational Minutes" or a substitute, the "Organizational Consent," is prepared following the incorporation.

An Employer Identification Number (EIN) is a nine-digit number (for example, 12-3456789) assigned by the federal government to sole proprietors, corporations, limited liability companies, partnerships, and other entities for federal tax filing and reporting purposes.

An entity may need to obtain an EIN if the entity:

• pays wages to one or more employees,
  
• files a tax Schedule C (Profit or Loss from Business) or Schedule F (Profit or Loss from Farming) on Form 1040 (U.S. Individual Income Tax Return) and has a Keogh Plan, or is required to file excise, employement, or alcohol and tobacco or firearms returns.
  Corporations must obtain and use an EIN even if they do not have any employees. If an entity already has an EIN, it may need to get a new one if either the organization or ownership of the business changes, for example, by incorporating a sole proprietorship. On the other hand, a new EIN should not be obtained if merely the name, but not the type, of the business changes.

In order for stock transfer restrictions to be enforceable, the buyer and seller of the stock must have actual notice of the transfer restrictions. Therefore, the restrictions should be noted conspicuously on the stock certificate (if certificates are issued) so that proposed purchasers of the stock have "actual notice" of the restrictions. If there are no Articles issued, actual notice should be provided to the shareholders (the potential sellers) and to the potential buyers when the corporation learns of the proposed sale.

Because the Articles of Incorporation are filed in the public records, all persons may be considered to have "constructive notice" of the provisions of the Articles. Therefore, consider adding restrictions to the stock certificates even if the language is included in the Articles of Incorporation. Restrictions noted on the certificate must be supported by an identical provision to that effect in the Articles or bylaws, or in a shareholder agreement.

If transfer restrictions are to be implemented, it is important to include them in the Articles or bylaws when the corporation is formed, rather than later by amendment, because restrictions implemented by an amendment to the Articles or bylaws are not binding upon shares already outstanding prior to the amendment unless the owners of those shares voted in favor of the amendment.

Most states create a statutory presumption that any officer of the corporation enjoys the authority to execute (sign) any written document, including, for example, documents for the sale of real estate, unless the Articles or bylaws may specifically provide otherwise

If it is desirable to restrict such authority to certain officers or officer combinations, the Articles or bylaws can include such a restriction, and, if filed in the county records, all relevant parties are deemed to have received constructive notice of the restriction. (Note that the bylaws must be recorded if they, rather than the Articles, contain such restrictions.) This option provides some security against unintended transactions by heedless officers.

Under new IRS "check the box" regulations, LLCs consisting of two or more members will be automatically taxed as partnerships unless they affirmatively elect to be taxed as a corporation. Single-owner LLCs will be taxed as a sole proprietorship unless they affirmatively elect to be treated as a corporation. In other words, for federal taxation classification purposes, the old four-factor test is no longer relevant.

LLCs can enjoy partnership, or sole proprietorship, "pass through" taxation of income even though they may be organized to have

1. limited liability,
   
2. unlimited life,
   
3. centralized management, and
   
4. free transferability of ownership.

A corporation is formed in California by filing a "Articles of Incorporation" (informally referred to as a "corporate charter") with the California Secretary of State. The Articles must contain a minimum set of required information; other information is optional. A filing fee must accompany the Articles. In conjunction with the filing of the Articles, it is necessary to also prepare corporate "bylaws" and either "organizational minutes" or an "organizational consent"; however, the bylaws and organizational minutes are not required to be filed with the Secretary of State.

A general partnership is like a sole proprietorship except that it is owned and managed by more than one owner.

1. Organizational Formalities. Generally, organizational formalities are not required by law to form a partnership, but often the partners adopt a partnership agreement that explains how the partnership will be operated and governed.

2. Personal Liability of Partners. Similar to a sole proprietorship, each partner is personally liable for all of the debts and expenses of the business; that is, each partner's liability is "unlimited." Further, each partner is liable for the acts of the other partners.

3. Income Taxation. The income and expenses of a partnership must be reported on a separate tax return (Form 1065). The net income of the partnership is then allocated to the partners, and the individual partners report their respective shares of the income on their individual income tax returns.

4. Taxation of Fringe Benefits. A partnership may have more flexibility in deducting the costs of providing fringe benefits to employees than a sole proprietorship, but the costs of such benefits provided for the partners themselves may not be deductible.

5. Use of a General Partnership. The partnership form of business is most often used for small businesses whose owners want to avoid the tax consequences that result from corporate ownership and are willing to accept personal liability. One of the main drawbacks of the general partnership is that the partnership is dissolved or liquidated whenever a general partner ceases to be a partner for any reason, unless the remaining partners agree to continue the business, which consent is often difficult to obtain.

Any person, partnership, association or corporation may act as incorporator, even if not a California resident. If no directors are named in the Articles, then the incorporator may take initial organizational steps, such as adopting bylaws and appointing officers and directors.

Corporations may not issue stock unless the transaction is qualified under federal and state securities laws or is exempt from qualification requirements. Most private companies issue stock under an exemption. We recommend that you contact an experienced corporate attorney for assistance before issuing shares of stock.

Stock may generally be issued for such consideration as determined by the board (or shareholders if required by the Articles) consisting of money paid, services rendered, debts cancelled, or property actually received. Promissory notes (unless fully collateralized by property other than the shares being issued) and future services cannot constitute payment for stock.

The LLC is a form of business entity which represents a second attempt (in addition to the "S" corporation) to combine the "limited liability" feature of the corporation with the tax advantages of the partnership. LLCs are a relatively new form of business entity. Wyoming enacted the first LLC statute in 1977 and, as of this writing, LLC statutes are in effect in all fifty states.

1. Organizational Formalities. The formation of an LLC is similar to the formation of a business corporation -- by Filing Articles of Formations with the Secretary of State. The Articles must include basic information regarding (1) the name and address of the LLC and its registered agent, and (2) its period of duration, for example, 10 to 35 years, although most states now permit perpetual duration.

   The Articles can also include provisions regarding (A) the management of the LLC by all members (the owners) or certain persons (who can, but need not be members), known as "managers," a term similar to corporate directors, (B) limited liability of its members and managers, and (C) whether less than a unanimous vote of the members is required to dissolve, sell or merge the LLC or amend its governing documents (see Articles of Organization and Operating Agreement). Some states still have statutes requiring an LLC to have two or more persons as members at the time that it is formed, but most states now allow single-member LLCs.

2. Operating Agreement. The LLC must also adopt an Operating Agreement that describes the rights and obligations of the members and how the LLC will be operated. The Operating Agreement is similar to a partnership agreement and somewhat similar to corporate bylaws.

3. A federal tax Employer Identification Number should be obtained, as well as possible permits and licenses, depending upon the activities of the LLC.

4. Limited Liability. Similar to a corporation, the owners ("members") of an LLC have "limited liability."

5. Income Taxation. The LLC usually attempts to avoid corporate taxation. For LLCs formed prior to January 1, 1997, it was necessary to carefully structure the LLC in order to avoid the characterization by the Internal Revenue Service that the LLC was so similar to a corporation that it should be taxed as a corporation. These objectives may still be important for purposes of state income taxation, so this program provides educational information about them. However, effective January 1, 1997, the Internal Revenue Service adopted new regulations, which, for federal income tax purposes at least, abandons the old "four-factor" test and allows most LLCs to be taxed like a partnership or Subchapter S corporation.

6. Use of LLCs. The LLC form of business entity is used primarily by small businesses that want:
   1. the limited liability protection of a corporation;

   2. the flexibility of organization and tax benefits of a partnership;

   3. the ability of the members to take part in the management of the business, unlike the prohibition that applies to limited partners in a limited partnership and the cumbersome three-tiered management structure of shareholders, directors and officers of a corporation;

   4. the protection to members afforded by many state statutes that disallow the transfer of any member's management rights in the LLC (versus "financial rights" which can often be transferred without restriction) without the consent of the non-transferring members; and

   5. freedom from the "S" corporation eligibility requirements. Although there are a few uncertainties involved with the formation of an LLC because it is a relatively new form of entity, there is an increasing trend toward the use of LLCs for small businesses, particularly service-oriented businesses.

A further variation of the general partnership is the LLP. The specific provisions of the LLP depend upon state law, but generally a partner in an LLP is not liable for the obligations of the partnership arising from the negligence, wrongful acts, or misconduct of another partner.

However, each partner remains liable for the general contractual and commercial obligations of the partnership and for his or her own acts. The LLP entity is popular primarily with multi-state accounting firms.

The limited partnership is a variation of the general partnership, designed to cure the "unlimited liability" disadvantage. A limited partnership has one or more of both "general" and "limited" partners. The general partner is responsible for the management of the partnership, receives a share of the partnership profits and losses, and is personally liable for the debts. The limited partners share in the profits and losses but are not permitted to have any management responsibilities. In return, their liability is limited to their investment in the partnership.

The limited partnership form of business is most often used for specific projects, for which a developer (the general partner with technical and management expertise) wishes to attract investors (limited partners) who do not want the risk of personal liability and are comfortable in allowing someone else to manage the project.

The bylaws or Articles must state the number of directors of the corporation. Alternatively, the bylaws or Articles must state a minimum and maximum number of directors (the maximum may not be greater than two times the minimum minus one), with the exact number of directors to be fixed, within the limits specified, by approval of the board or the shareholders.

California generally requires a minimum of three directors, but will allow for a single director if the corporation has not yet issued shares or is owned by only a single shareholder and for two directors if the corporation has no more than two shareholders.

Because these Articles are prepared for start-up corporations, there is probably no need to authorize a huge number of shares. "Authorized" shares refers to the total number of shares that can be sold ("issued"), either upon formation or at a later time. �Issued� shares refers to the total number of shares actually issued to shareholders, and must be less than or equal to the authorized shares. The number authorized need only be large enough to be able to reflect the percentage ownership of the owners.

For example, if Bob and Ted intend to own the entire corporation in a 60-40 ratio, respectively, the corporation could authorize 100 shares and issue 60 to Bob and 40 to Ted. In fact, the corporation could issue 6 to Bob and 4 to Ted, and, as long as the other 90 shares are retained by the corporation as �authorized but unissued� shares, Bob and Ted still own their desired percentages of the corporation because they own all of the stock that the corporation has "issued."

It is suggested that 1,000 shares be initially authorized. The shareholders can authorize additional shares later by amending the Articles.

Organizational formalities in a Corporation include these items (and others not listed here):

1. Articles of Incorporation. The corporation is formed by Filing Articles of Incorporation with the Secretary of State. The Articles must include basic information regarding the names and addresses of the corporation, the registered agent, and the incorporator, as well as the number of authorized shares of stock. In addition, the Articles can include provisions regarding limited liability of the directors, preemptive stock rights, staggered directors' terms, and any unusual shareholder meeting requirements.

2. Organizational Minutes (or Consent). A corporation is also required to hold an organizational meeting to elect initial directors (unless already named in the Articles of Incorporation), elect officers, adopt Bylaws and take care of other organizational matters. Corporate minutes are prepared in order to document the decisions reached and actions taken. Instead of an actual meeting, these organizational activities can be handled by a written "organizational consent" signed by all of the incorporator(s) or the initial directors, unless such a method is prohibited in the Articles.

3. Bylaws. In addition to a Articles of Incorporation, a corporation must have a set of Bylaws which define how the business and affairs of the corporation will be managed and regulated. Typically, a set of Bylaws includes provisions regarding shareholder meetings and voting, and the duties, qualification, election, terms and meetings of the directors. The Bylaws (or the Articles) may also include provisions regarding stock transfer restrictions, the execution of written instruments, higher-than-majority quorum requirements for director meetings, and indemnification of directors.

4. Stock Certificates. A corporation may choose to issue stock certificate as evidence of the ownership by the shareholders of their respective interests in the corporation. However, physical Articles are not always required.

5. Federal Tax Employer Identification Number (EIN). An EIN must be obtained for the corporation using Internal Revenue Service tax form "SS-4." Other forms, applications and licenses may be required, depending on the activities of the corporation. For example, there may be a need to register as a contractor, or the need to obtain a sales tax permit.

6. Minutes/Annual Reports. After formation, the corporation must observe certain formalities in order to preserve its separate legal status. Minutes or other records of shareholder and director action must be prepared at least annually. Additionally, annual reports generally must be filed with the Secretary of State.

There are several types of business entities that you can create. Therefore, we recommend that you read the topics under Types of Business Entities before continuing with the Articles of Incorporation. If you determine that a corporation is the proper type of entity for your needs, the Articles of Incorporation ("Articles") is one of several instruments which are required in order to form a regular, for-profit corporation ("business corporation").

If the business operations of the entity will be located in the state of California, then most likely the corporation should be formed under California law. If the business operations of the entity will be located in a state other than California, it rarely makes sense to incorporate in California because

• the corporation would have to qualify as a "foreign corporation" in the state where it will operate,
  
• annual fees and license taxes would have to be paid in both states, and
  
• if a legal problem arises related to the corporation's business, a lawyer licensed to practice in California would have to be consulted.

The issues addressed in the preparation of this document will be similar for states other than California, and you will need the information this interview requests if you plan to consult an attorney regarding incorporation in a state other than California. However, the Articles of Incorporation Worksheet is designed specifically for other states, and you may want to use that document instead.

IMPORTANT: This set of Articles is intended to be used by a corporation which will be formed and initially owned by a small number of shareholders. Before any shares of stock are sold or issued, the corporation must comply with the Corporate Securities Act administered by the California Department of Justice. Both state and federal securities laws will apply to the sale or issuance of stock by the corporation, and before issuing any stock you should consult with a corporate or securities attorney.

IMPORTANT: This set of Articles is appropriate for use in forming a "general purpose" corporation. If you are interested in forming a professional bank or trust company, insurance company, close corporation, or professional corporation, then special laws apply and you should consult with a corporate attorney.

Many companies choose to authorize stock with no par value. California and most other states allow "no par stock." In the past, corporations designated a par value of, for example, $15 per share, in order to set a minimum price at which the shares could be initially sold by the corporation. More importantly, for the protection of the corporation's creditors, the corporation could not distribute cash to the shareholders which would deplete the corporation's "capital" below the aggregate par value of all issued shares. However, today's creditors typically restrict such distributions by separate agreements with the corporation, so there is little necessity to designate a par value merely to satisfy creditors.

Preemptive rights give existing shareholders the right to purchase sufficient shares -- whenever the corporation intends to issue more shares -- so that those existing shareholders can maintain their percentage ownership of the corporation. Because the authority to issue new shares typically rests with the board of directors, a majority stockholder could effectively vote to sell new shares to himself which would dilute the percentage interests of the minority shareholders and allow the majority shareholder to control major decisions which could otherwise have been blocked by the minority shareholders.

For example, suppose the corporate bylaws required a 75% approval by the shareholders in order to sell a major corporate asset, such as a factory. Shareholder Smith owns 55% of the outstanding stock of the corporation, not enough to approve the sale without the consent of the owners of another 20% of the shares. Therefore, Shareholder Smith votes to sell enough new shares to himself, and not the others, so that his percentage ownership of the corporation exceeds 75%, allowing him to unilaterally approve the sale of the factory. Therefore, preemptive rights are usually intended for the protection of minority shareholders.

Professional corporations are a variation of the basic corporate form. They are used by professionals -- persons who are required to obtain a license from the state in order to practice their profession, for example, physicians and lawyers.

A shareholder in a professional corporation must be a licensed professional in the same profession, and continues to be personally liable for his or her own professional conduct. But the professionals do receive liability protection with respect to the professional conduct of the other shareholders.

Bylaws, unlike the Articles, are not usually required to be recorded in the public records (see Execution of Written Instruments for an exception). Thus, outside parties are not likely to know of the contents of the bylaws. If there is a restriction on the transfer of stock, for example, consider placing that provision in the recorded Articles or on the stock certificat itself so that third parties who would otherwise attempt to purchase the stock in violation of the restrictions will be deemed to have notice of those restrictions.

In California, every corporation registered or doing business in the state must designate an agent for service of process, who is located in California and is authorized by the corporation to receive notices from any entity attempting to sue the corporation.

You may designate either an individual who resides in California or a corporation as your initial agent for service of process. Corporate agents are required to have registered with California under Section 1505 of the Corporations Code, and their capacity to act as agent must not have terminated. Note that in California, a corporation cannot act as its own registered agent. Most corporations who have their principal office in a state other than where they incorporate utilize a service company who acts as registered agent for a large number of corporations for a fee.

1. The California Secretary of State requires that all documents be typed with letters in dark contrast to the paper. Documents that would produce poor quality microfilm will be returned unfiled.

2. The Articles of Incorporation should be signed in black ink by each Incorporator or, if the Articles name the initial directors, then by all the initial directors. If initial directors are named, they must both sign and �acknowledge� the Articles, meaning that they must either: (a) sign in the presence of a notary, or (b) submit a signed declaration stating who they are and that the Articles are their own act and deed.

3. The original signed Articles, and two photocopies, should be mailed to the Secretary of State, Business Programs Division, 1500 11th Street, Sacramento, California 95814, ATTENTION: Document Filing Support Unit, along with a check for the filing fee ($100 as of this writing) made out to �California Secretary of State�. To facilitate processing, you should include a cover letter with your corporate name, your own name, return address and telephone number, as well as a self-addressed envelope for the return certified copy of the Articles. The Secretary of State will certify a copy of the Articles and return it to you (processing times as of this writing are 4-6 weeks). A photocopy of the certified Articles should be retained for the corporate files.

4. You may also hand-deliver the Articles for filing at the Secretary of State�s offices in San Diego, San Francisco, Los Angeles or Fresno, but please note that these offices do not accept mailed-in documents.

5. A lawyer or tax advisor should be consulted regarding the advisability of electing to be treated as a "Subchapter S" corporation for federal income tax purposes. THIS ELECTION MUST BE POSTMARKED NO LATER THAN TWO MONTHS AND 15 DAYS AFTER THE BEGINNING OF THE CORPORATION'S TAXABLE YEAR, and should be sent by certified mail as evidence of the date of mailing.

   The corporation is formed as of the date that the Secretary of State files the document in the state corporate records. However, additional steps must be taken to complete the organization:

   1. The incorporators or the initial directors must adopt "Bylaws" and obtain a federal tax "Employer Identification Number."

   2. The Articles must also be filed with the County Recorder where the registered office is located. However, the California Secretary of State will usually forward a copy of the Articles to the appropriate Recorder for this purpose.

   3. An "organizational meeting" of the incorporators (or the initial directors, if they were named in the Articles) must be held. Alternatively, such incorporators (or initial directors, if named) can sign an "Organizational Consent " without a meeting.

      Assuming that the initial directors were named in the Articles, the minutes SHOULD include a description of the actions taken to complete the organization, such as:

      • Adoption of the Bylaws,
        
      • Appointment of officers, and
        
      • Election of officers.
      
      The minutes CAN include other resolutions, such as:
      • Issuance of a specified number of shares to specific persons for a stated consideration
        
      • Acceptance of specific assets or liabilities by the corporation
        
      • Authorization to the president to obtain an Employer Identification Number
        
      • Authorization to the president to establish a corporate bank account and to borrow specific sums of money
        
      • Approval of a fiscal or calendar year for the corporation
        
      • Authorization to the president to file a tax election to be treated as a "Subchapter S" corporation
        
      • Authorization for the corporation to lease office space upon certain terms
        
      • Authorization and direction to the officers to obtain appropriate insurance coverage
        
      • Authorization to the president to adopt pension and/or profit sharing plans for the employees
        
      • Authorization to the president to enter into employment agreements with specific officer-employees
      
      If an organizational meeting will be held, the incorporators (or initial directors, if named) must be given at least two days' prior written notice of the meeting, unless they attend the meeting in person or individually waive such notice.

   4. There are other documents and forms that are commonly prepared in connection with the formation of a corporation. These can include shareholder voting agreements, long-term employment agreements, stock transfer restriction or buy/sell agreements among the shareholders, a lease or franchise agreement, a loan agreement, "Subchapter S" election, patent or trademark application, application for necessary licenses and permits, and trade name filings.

   5. Additionally, minutes of shareholder and director meetings must be prepared at least annually. An Annual Statement of Information and an Annual Tax Return must be filed with the Secretary of State and Franchise Tax Board, respectively.

   6. Finally, it is important to pay close attention to the necessity of respecting the corporate formalities on an on-going basis. Occasionally, the IRS or a court will find that the activities of the corporation are indistinguishable from the financial affairs of the shareholder(s). This is called "piercing the corporate veil" and can result in the shareholder(s) being personally liable for the corporation's debts and/or being held to have personally received the corporation's income. In order to avoid these consequences, the corporation should have an adequate capital investment, maintain an up-to-date stock ownership ledger, preserve strict segregation of corporate versus personal cash funds, and hold at least annual meetings of the shareholders and directors which are documented with minutes.
   
   
6. A lawyer should be consulted regarding any unique issues not addressed by this program, especially in situations where investors will be sought to purchase stock in the new corporation.

A sole proprietorship is an unincorporated business owned and managed entirely by the "proprietor," except to the extent that the proprietor may delegate management responsibilities to an employee. It is the simplest form of business. However, simplicity may be the only advantage of the sole proprietorship.

1. Organizational Formalities. There are no organizational formalities required and generally no other agreements necessary. However, if the business will have employees, a federal tax Employer Identification Number will be required. A sales tax permit and/or licenses may be required.

2. Liability of Owner. The owner is personally liable for all of the debts and expenses of the business, that is, the owner's liability is "unlimited." If the business is unable to pay its obligations, the non-business assets of the owner will be at risk unless protected by an exemption (for example, the homestead exemption for the owner's personal residence). Some protection can be obtained through liability insurance.

3. Taxation. The income and expenses of the sole proprietorship are reported as part of the owner's individual income tax return. Tax advisers have noted that sole proprietorships have a higher rate of income tax audits than the same businesses run as corporations. There is no extra tax return to be prepared each year. Every other form of business entity requires a separate tax return for the business (except an LLC taxed as a sole proprietorship).

4. Taxation of Fringe Benefits. A sole proprietorship generally has less flexibility to deduct the costs of fringe benefits, which means fewer after-tax dollars.

5. Use of the Sole Proprietorship. The sole proprietorship form of business is most often used for small, low-risk businesses that have only a few employees and no need for more than one owner.

The bylaws may specify that the corporation chooses not to issue stock certificates. Because a stock certificate is not ownership itself but merely tangible evidence of ownership of the shares, Articles are not essential to owning stock. Corporations with only a few shareholders may feel that there is no need to incur the added expense of issuing Articles. In that case, the corporate stock register records will be relied upon to indicate the ownership of the outstanding stock. However, the corporation is generally required to issue certificates upon demand by a shareholder, and most corporations choose to issue Articles as a rule.

The corporation may wish to restrict the ability of shareholders to sell their shares to outsiders, in order to maintain the "closely-held" nature of the corporation. The restrictions may also be important to protect advantageous tax treatment, for example, to restrict the number of shareholders to less than 75 in order to preserve the right to be classified as a "Subchapter S" corporation.

A common example of a transfer restriction is to give the corporation a "right of first refusal," whereby any shareholder proposing to sell his or her stock must first offer to sell such stock to the corporation on the same terms.

Both business corporations and professional corporations can make a special "S" corporate election that alters how the income of the business is taxed. After forming a corporation, the shareholders elect "S" status for tax purposes under Subchapter S of the Internal Revenue Code by filing Form 2553 with the Internal Revenue Service on or before two months and 15 days after the beginning of the taxable year in which it is to be effective.

The income and expenses of an "S" corporation are reported on a separate tax return (Form 1120S), but like a partnership, the net income of the "S" corporation is then allocated to the shareholders who report their respective shares of the income on their individual income tax returns. Therefore, the "S" corporation combines the "limited liability" feature of the regular corporation with the tax advantages of the partnership.

A disadvantage of the "S" corporation is the number of technical tax rules. For example, the following rules (among others) apply:

1. Number of Shareholders. An "S" corporation may not have more than 100 shareholders.

2. Type of Shareholders. Shareholders must be individuals (or certain trusts) rather than entities, and must not be non-resident aliens.

3. One Class of Stock. An "S" corporation may only have one class of stock.

4. Calendar Year-end. Generally, the corporation must use a tax year that ends on December 31 of each year, unless the corporation can show that it has a "peak period" of business that ends other than shortly before December 31.

5. Fringe Benefits. Some types of fringe benefits (for example, health insurance benefits) are not deductible for shareholders who own more than 2% of the corporation.

Many new closely-held corporations benefit by making a tax election to be treated as a "Subchapter S" corporation for purposes of classification by the Internal Revenue Service. For example, this allows corporate losses, which are common in the initial years of the corporate existence, to "flow through" to the shareholders' personal tax returns as an income tax deduction, and allows profits to be distributed without the double taxation (once at the corporate level and again at the shareholder level when dividends are paid) that is characteristic of regular corporations.

In order to qualify to make the "S" election, there are several eligibility requirements, including:

1. The corporation must not have more than one class of stock.
   
2. The corporation must not have more than 100 shareholders.
   
3. shareholders must be individuals (or certain trusts) rather than entities, and must not be non-resident aliens.

Note: The deadline for making the election is two months and 15 days after the beginning of the taxable year for which it is to be effective. The election should be sent by certified mail as evidence of the date of mailing.

Generally, directors hold terms of office of one year, and at each annual meeting of shareholders, directors are elected to hold office until the next annual meeting.

If there will be more than one regular director (those elected by the shareholders),consider dividing the directors into two or three classes with terms of two or three years, respectively, so that one class of directors expires each year (after the initial shareholder's meeting). The use of this method provides continuity on the board because only one-half or one-third of the board may be replaced at any one time.

California law requires that if the board of directors is divided into two classes, the authorized number of directors must be at least six, and half of the directors (or as close an approximation as possible) shall be elected at each annual meeting of shareholders. If the board of directors is divided into three classes, the authorized number of directors must be at least nine and one third of the directors (or as close an approximation as possible) shall be elected at each annual meeting of shareholders.

There are four basic types of business entities: the Sole Proprietorship, the Partnership, the Corporation and the Limited Liability Company (the "LLC"). In addition, there are several subtypes.

A typical set of bylaws will include the following topics, unless such topics have already been addressed in the Articles:

• Fix the number of directors, the duration of their terms, whether they will be separated into classes, and how vacancies will be filled.
  
• Specify the notice, quorum and other voting requirements for "regularly scheduled" and "special" the director's meetings.
  
• Allow the directors to delegate power to a committee of directors.
  
• Specify whether the directors or shareholders can take action by written consent without a meeting.
  
• Specify whether the directors shall have the ability to establish their own compensation.
  
• Establish the corporation's officers, describe their duties, specify whether an individual may hold multiple officer positions, and prescribe the method of appointing and removing officers and filling vacancies.
  
• Indemnify the directors, officers and other agents of the corporation against personal liability up to the maximum extent allowed under law.
  
• Restrict the transfer of stock to outside parties.
  
• Designate the date, time and location of the annual meeting of the shareholders.
  
• Specify the notice, the quorum and other voting requirements for shareholder meetings.
  
• Specify whether cumulative voting is allowed by shareholders in electing directors and, if so, how such cumulative voting rights may be exercised.
  
• Specify whether the corporation will have a corporate seal.
  
• State whether the corporation will issue stock certificates.
  
• Specify how the bylaws may be amended.