Steps to Forming A Corporation

Forming A Corporation - Choose Your Corporate Name

Your new corporation's name has to pass muster with the California Secretary of State's office, which handles incorporations and maintiains records of corporations doing business in the State.  Your new corporation's name must end in a word such as company, incorporated, or limited (or their abbreviations), so that people will know they're dealing with a business that has limited liability, not a sole proprietorship with unlimited liability.

The Secretary of State's office also won't allow your new corpoaration's name to be the same, or confusingly similar to, the name of a corporation that already exists.  Don't expect your initials to be available as a name.  People forming a corporation to hold real estate often use the street address, e.g., 2415 Willow Road, Inc., which is usually available. 

For a small fee the Secretary will reserve a name for you for 60 days, but that's probably overkill.  You can enter any name you want in the name search section of the Secretary's web site.  If nothing comes up, the name is available.  In that case, obtaining a reservation is likely to be a waste of time and money, and we usually just file your articles immediately.  

Prepare the Articles of Incorporation

"Articles of Incorporation" sounds impressive, but they're actually simple and usually only two pages long.  In some states the articles are called charters.  The articles state the corporation's name, the buisness it intends to engage in (usually, "Any busines lawful in the State of California"), the corporation's principle place of business (its address), the number of shares the corporation is authorized to issue, and the name and address of its authorized agent for service of process.  The address of the agent can't be a post office box, and it must be in California.  The articles are signed by the "incorporator."

The authorized number of shares is usually arbitary when a small business incorporates.  Let's say the business is a partnership of two people who own it 50/50.  The corporation could be authorized to issue two shares, and each of them could purchase one share.  Our two hypothetical owners would probably want more impressive numbers, perhaps 10,000 shares authorized and 1,000 issued to each of them.

The articles of incorporation require the name and address of an authorized agent for service of process, so that anyone who wants to sue a corporation whose officers, managers, and offices are far away or can't be found, can easily start the lawsuit by serving them on the authorized agent for service of process. 

An attorney forming a corporation used to be happy to name himself as its agent for servce of process.  However, being served with a lawsuit against a corporation which is no longer a client, and whose owners may have disappeared, creates problems.  These days the designated agent for service is more likely to be one of the owners of the business being incoroporated.  Lawyers also used be happy to serve as incoporators, but that too has become a risky business, so the incoporator signing the articles is also likely to be one of the owners of the business being incoroporated.

File the Articles of Incorporation

The incorporator, usually acting through a lawyer for the owners, delivers the articles of incorporation to the Secretary of State's office for filing.  Unless the name is objectionably obscene, they are filed as a matter of course.  The articles are "filed" when the clerk stamps them with the Secretary of State's offical stamp, which shows the date the stamping occurred.  The current backlog at the Secretary of State's office is causing a considerable delay in getting articles filed.

Once the articles are filed, the corporation has something called "bare legal existence." This doesn't count for much. if anything, because filing the articles of incorporation don't' transfer ownership of the business from the pre-filing owners to the corporation.  They still own the business, and they don't yet own the corporation, which means they don't yet have limited liability. 

The incorporator now solves what would otherwise be a chicken and egg problem: someone has to propose the corporation's bylaws (which is the only  document saying how many directors the corporation must have), and someone has to designate the corporation's intial directors, without whom officers can't be elected and stock can't be issued.  That someone is the incorporator.  After the incorporator proposes the bylaws and designates the initial directors, who are usually the owners of the business, the incorporator resigns.

Hold the Organizational Meeting

The next critical step is the organizational meeting of the directors.  Its significance tends to be overlooked, because there is usually no actual meeting.  Instead the directors waive notice of the meeting and act by unanimous consent, a procedure the Corporations Code allows.  In practice this means they all sign minutes of a fictitious meeting, which contain a series of written actions called resolutions.  The minutes may be a fill-in-the-blanks form included in a corporate kit purchased over the Internet, or a completed document out of an attorney's word processor.

The resolutions follow a standard pattern.  Adopiton of the bylaws proposed by the incorporator usually comes first, then the election of officeers.  A president, secretary, and treasurer are the required minimum.  In a small business incorporation, the officers are usually the same people as the directors,

The next resolutions are typically what you might call housekeeping matters - adopting a corporate seal, adopting a form of stock certificate, and designating the corporation's bank,

Then comes the resolution that actually breathes life into the beast.  This resultion authorizes the president and secretary to issue shares of stock in the corporation. Stock may be issued for cash, an in kind contribution, or past services.  It cannot be issued for future services.  In a start up situation, the stock is typically issued for cash, enough cash to get the new business up and runniong. 

When an exisitng business is being incorporated, the stock is issued in exchange for the businees assets - its name, its inventory, its equipment, and its cash in the bank.  In other words, the owners of the existing business give the business to the new corporation in exchange for its stock.  Typically the new corporation also assumes the existing oblilgations of the business.  The new corporation now owns the business, and the former owners of the business now own the new corporation.

As it appears in the minutes of the organizational meeting, the resolution authorizing the issuance of shares of stock will typically list the owners of the existing business, the number of shares to be issued to each of them, and the "consideration" to be paid for the shares.  Bear in mind that resolving to issue the shares is not the same thing as actually issuing the corresponding stock certificates, and that actually issuing them is essential.  More on that below.

When shares are issued in exchange for an existing business, the "consideration" will be the dollar value of the business.  The exchange is not a taxable event, but the shareholder's tax basis in the shares will be the value of the business.  To minimize gain when and if the shares are sold, a high basis might be helpful. Talk to your CPA about this.  There may be potential future problems if the business is grossly overvalued in the minutes.

A few more resolutions must still be adopted.  Typically they are instructions from the directors to the new officers to accomplish tasks that must be perfomed to complete the incorporation process.  Those tasks include filing with the Secretary of State the required notice of issuance of shares and the first of the anually required "Statement of Domestic Stock Corpration" forms.  They may also include obtaining an employer identification number and filing the IRS form electing that the corporation be taxed as a partnership, which will make it a "Subchapter S corporation." 

That ends the organizational meeting. The directors sign the minutes of the meeting, and the secretary puts the articles of incorporation, the bylaws, and the minutes of the meeting in the minute book. 

Issue the Stock Certificates

But we're not quite done.  The president and the secretary must then actually issue to the shareholders the stock certificates for their shares.  If the consideration includes cash, they must alo collect it and depositi it the corporation's new bank account.  Typically the certificates are professionally printed on heavy paper.  On each certificate the secretary fills in the shareholder's name, the number of shares, and the date.  The president and secretary sign the certificate, and the secretary embosses the certificate with the corporation's seal.  After all the certificates have been issued, the secretary enters their issuance in the stock ledger, which also goes in the minute book.  Finally the secretary delivers the certificates to the shareholders, who should put them in their safe deposit boxes.

Unless all these steps are followed, the new corporation will be defectively incorporated, placing the shareholders' limited liability in jeopardy.

By Stanley D. Prowse 2015

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