Theta Law Firm, LLP | California Closely Held Corporation Requirements and Formation

California Closely Held Corporation Requirements and Formation

The attorneys of Theta Law Firm can advise you in your business formation, transactional, and investment needs.

The California Corporations Code allows for the creation of a statutory close corporation. Qualifying businesses can form a California close corporation to avoid some of the formalities applicable to California Corporations generally. Shareholders are given more direct control over the corporation. The reduced requirements for close corporations makes it harder for creditors to go after the personal assets of shareholders.

Under California law, the failure of a close corporation to observe corporate formalities relating to certain meetings of directors and shareholders cannot be considered a factor when determining whether a shareholder will be personally liable for corporate obligations. (See California Corporations Code section 300.) In other words, in some circumstances, the failure to comply with certain corporate formalities cannot be used against shareholders (whereas they can be with regular corporations).

Close Corporation Requirements:

The Articles of Incorporation must state how many shares the corporation is authorized to issue (that number cannot exceed 35). It must also specifically state that the corporation is a close corporation. A form for the Articles of Incorporation of a California close corporation can be found on the California Secretary of State's website here: http://www.sos.ca.gov/business/corp/pdf/articles/arts-cl.pdf. You can use this form or create your own.
California close corporations cannot have more than 35 shareholders. Corporations, partnerships, and other business associates are considered one shareholder for purposes of this requirement, unless the primary purpose of the entity was to acquire the close corporation's shares. Spouses are also considered one shareholder.
Shareholders should execute a written agreement setting forth what decisions the shareholders must exercise control over, as opposed to the corporation's board. This agreement must be maintained by the corporation's secretary.
The share certificates issued by a California close corporation must conspicuously state: "This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed 35. Any attempted voluntary inter vivos transfer which would violate this requirement is void. Refer to the articles, bylaws and any agreements on file with the secretary of the corporation for further restrictions."
California close corporations cannot go public.

Benefits of a Close Corporation:

Close corporations can allow greater control by minority shareholders. Owners are generally provided greater latitude in operating their close corporation.
Profits may be distributed disproportionately to share ownership (this may disqualify you from the ability to elect S corporation status).
Corporate formalities can be dispensed with to the extent allowed for in the corporation's shareholders' agreements and by-laws.
It may be harder for third parties to "pierce the corporate veil" and go after your personal assets if you have a properly formed close corporation.

Drawbacks of a Close Corporation:

You may need to follow some of the standard corporate formalities anyway because some third parties you do business with may require some of those formal documents to do business with you.
Shareholders who manage the business can still be liable for breach of fiduciary duties that are applicable to directors/officers of regular corporations.
Forming a close corporation can be more expensive because it requires the creation of a shareholder's agreement.
A California close corporation may not be able to elect S corporation status if it distributes profits disproportionately.
Close corporations may be less attractive to investors because of the restrictions on transferring shares and the power of even minority shareholders to help manage the corporation.