The AllBusiness.com Practical Guide to Incorporation

The AllBusiness.com Practical Guide to Incorporation
Table of Contents:
CHAPTER 1 THE KEY CHARACTERISTICS OF A CORPORATION				1
	Overview			1
		Defined		1
		Life of a Corporation		1
		State Law		1
	Where to Incorporate?			2
		Other Considerations		2
		Delaware		2
		Nevada		3
		Secretary of State		4
			Do I Need to Hire an Attorney to Incorporate My Business?	4
			How Do I Find A Corporate Attorney?	5
			Ten Questions to Ask Your Business Lawyer	5
	Limited Liability			6
		Defined		6
		Exceptions		6
			Piercing the Corporate Veil	6
	Corporate Formalities			7
		Advantages and Disadvantages of Forming A Corporation		7
			Advantages	7
			Disadvantages	9
	Costs			10
		Ranges for Incorporation Costs		10
		Filing Fees		10
		Franchise Tax Payment		10
		Government Filings		10
		Attorney Fees		10
CHAPTER 2 CHOOSING A CORPORATE NAME				12
	Is the Name You Want Available?			12
		Several Name Choices to Start		12
		Choose A Desirable, Usable Name		13
		Legal Restrictions and Requirements for Name		14
			Secretary of State Information	14
		Check Name Availability in Chosen State of Incorporation		14
			General Rule	14
			Contact Secretary of State	14
		Incorporation Services		15
		Search Other Sources		15
	Trademark Considerations			16
		Key Terms Defined		16
		State Trademark Search		17
		Common Law Search		17
		Trademark Search Online		18
		Trademark Search Companies		18
	Reserve Corporate Name			18
	Domain Name			19
		Domain Names Explained		19
		Domain Name Search		19
		Domain Name Registrars		19
		Register Domain Name		20
		Domain Name Registration Steps		20
CHAPTER 3 THE KEY DOCUMENTS FOR FORMING A CORPORATION				22
	Articles of Incorporation			22
		Defined		22
		Filing and Fees		22
		Formation of Legal Entity		22
			Secretary of State Information	23
			Basic Requirements for Articles of Incorporation	23
		Requirements		23
		Additional Requirements		24
		Optional Additional Sections for the Articles		24
			Privacy Issues	25
		Amending the Articles		25
		Incorporating Services		25
	Action of Incorporator			26
	The Bylaws			26
		Defined		26
		Default Provisions		27
		Function		27
			Five Reasons Your Corporation Should Adopt Bylaws	27
		Bylaw Provisions		27
		Amending the Bylaws		29
		Maintaining the Bylaws		29
	The Organizational Resolutions			29
		First Meeting of Board of Directors		29
		List of Potential Resolutions for First Meeting of the Board of Directors		30
	Corporate Records Book			31
	The Stock Ledger			31
		Information Recorded in Stock Ledger		31
CHAPTER 4 CAPITALIZING THE CORPORATION				33
	Stock Issuance			33
		Common Stock		33
		Preferred Stock		34
		Right of First Refusal Agreement		34
	Checklist For Issuing Stock			34
	Securities Laws			36
		Federal Securities Laws		36
			General	36
			Antifraud Provisions	36
		Accredited and Unaccredited Investors		37
		Exemptions		37
		State Securities Laws		39
			General	39
			Qualified and Unqualified Investors	39
			Exemptions	39
		Hire a Good Securities Lawyer		40
	Angel Financing			40
		General		40
		Finding Angel Investors		41
	Venture Capital			41
		General		41
		Stock Purchase Agreement		41
		Finding A Venture Capital Firm		42
	Debt			42
		General		42
		Lenders		42
		Lender Questions and Document Requirements		43
		Loan Arrangements		43
	Promissory Notes			44
		General		44
		Usury Laws		44
		Payment Terms		45
CHAPTER 5 OFFICERS AND DIRECTORS				46
	Secretary of State			46
	The Role of Directors			46
		Defined		46
		Qualification and Number of Directors		47
			Qualification	47
			Number of Directors	47
		Initial Appointment or Election		47
		Board Compensation		48
		Duties and Responsibilities		46
			Duty of Care	48
			Business Judgment Rule	48
			Duty of Loyalty	48
		Executive Committees		49
		Conflicts of Interest		49
	The Role of Officers			50
		Defined		50
		Signature of Officers		51
		Compensation of Officers		51
		Employment Agreements		52
	Liability Issues for Officers and Directors			52
		When Liability Exists		52
		Personal Liability of Officers and Directors		52
		Indemnification of Officers and Directors		52
		Directors' and Officers' Insurance		53
	Changing Directors and Officers			53
		Changing Directors		53
			Cumulative Voting	54
		Changing Officers		54
CHAPTER 6 TAXES				55
	Accounting Elections			55
		Tax Year		55
		Cash or Accrual Accounting		56
			Cash Method	56
			Accrual Method	56
	C Corporations			56
		General		56
		Benefits of Separate Taxable Entity		56
			Retained Earnings	57
			Salaries and Bonuses	57
			Fringe and Other Benefits	56
			Losses	57
	Taxpayer Identification Number			57
		Defined		57
		Use		58
		When Required		58
		Obtaining an EIN		58
	S Corporations			58
		General		58
		Benefits of S Corporation Election		59
			Hire a Tax Professional	60
	Tax Resources and Advice			60
		Tax Resources		60
		Tax Advice		60
	Tax Returns			61
		C Corporations		61
		S Corporations		61
		Avoid Penalties for "Failures"		61
	W-2s (and W-4s) for Employees			62
		IRS Form W-2 (Wage and Tax Statement)		62
		IRS Form W-4 (Employee's Withholding Allowance Certificate)		63
	Payroll Taxes			63
		Federal Income Tax Withholding		63
		Social Security and Medicare Withholding		63
		Federal Unemployment (FUTA) Tax		63
		Other Workers (Independent Contractors)		64
	Sales Taxes			64
		In-Person Sales Transactions		64
		Internet Sales Transactions		64
CHAPTER 7 THE KEY LAWS AFFECTING CORPORATIONS				66
	State Corporate Law			66
	Securities Laws			66
	Tax Laws			67
	Employment Laws			67
		Employment Law Issues		67
		Workers' Compensation		68
		OSHA		68
		Form I-9		68
		Federal Anti-Discrimination Laws		68
			Title VII of the Civil Rights Act of 1964	69
			The Equal Pay Act of 1963	69
			The Age Discrimination in Employment Act (ADEA)	69
			The Civil Rights Act of 1966	69
			The Immigration and Reform Act of 1986	69
			The Americans with Disabilities Act (ADA)	69
		Other Laws		69
		Employment Law Web Resources		70
		Consumer Protection Laws		70
			Consumer Protection Resources	70
		Intellectual Property Laws		71
			Copyright	71
			Patents	72
			Trademarks and Trade Secrets	72
		Environmental Protection Laws		73
CHAPTER 8 FOLLOWING PROPER CORPORATE FORMALITIES				74
	Shareholder Meetings			74
		Annual Meetings		74
		Special Meetings		74
		Shareholder Action by Consent		75
		Voting		75
			Record Date	75
			Quorum	75
			Proxy Voting	75
		Minutes and Written Consent		76
	Director Meetings			76
		Director Action by Consent		76
		Voting		77
			Quorum	77
			Supermajority	77
			Proxy Voting	77
		Minutes and Written Consent		77
	Signing Documents as A Corporation			78
		Signature of Officers		78
	Letterhead			78
	Corporate Recordkeeping			79
		Financial Record Keeping		79
		Corporate Record Keeping		79
	State Annual Filings			79
		Corporate Report (Annual or Biennial)		79
		Corporate Franchise Tax Form		80
		Corporate Tax Returns		80
			Corporate Income Tax	80
			Other Federal Taxes	80
		Tax Advice		81
	Bank Accounts			81
		Establishing Accounts and Records		81
		Significant Financial Transactions		82
		Maintain Separate Accounts		82
	Financial Statements			81
		Income Statement		82
		Balance Sheet		83
			Assets	83
			Liabilities	83
			Net Worth	83
		Cash Flow Statement		83
CHAPTER 9 KEY AGREEMENTS FOR THE CORPORATION				85
	Employee Hiring Forms and Agreements			85
		Employment Applications		85
		Employment Offer Letters		86
		Employment Agreements		86
		Confidentiality and Invention Assignment Agreements with Employees		87
		A Practical Tip-New Employee Paperwork		88
	Stock Purchase Agreements			88
	Right of First Refusal Agreements			89
	License Agreements			89
	Confidentiality and Non-Disclosure Agreements			90
	Sales Contracts			91
	Office Leases			92
		Lease Gotchas		93
CHAPTER 10 PROTECTING YOURSELF AND THE CORPORATION FROM LIABILITY				94
	Risks			94
		Directors		94
		Sole Shareholder		95
	Adequate Capitalization			95
	No Commingling Assets			95
	Insurance			96
		Defined		96
		General Types		96
		Business Owner's Policies (BOPs)		96
		Checklist of Different Types of Insurance Available for a Small Business		98
		General Liability Insurance		98
		Checklist of Issues to Review for General Liability Insurance		99
		Property Insurance		99
		Directors' and Officers' Insurance		100
	Employee Lawsuits			101
		At-Will Employee		101
		Employee Handbook		101
		Terminating Employees		102
	Contract Protection from Liability			102
CHAPTER 11 BUSINESS REGISTRATIONS AND LICENSES FOR CORPORATIONS				104
	Business Licenses			104
		Fictitious Business Name Statement		104
			Purpose	104
			Defined	104
			Filing and Notification	104
			Choosing A Corporate Name	105
		Local Licenses		105
			Business License (Local Tax Registration Certificate)	105
			Zoning Permits	105
		State and Federal Licenses and Permits		105
		Information about Licenses and Permits		106
	State Informational Filings			106
	Doing Business in Other States			106
		Foreign Corporation Defined		106
		Qualification or Registration Requirements		107
		Secretary of State		107
		Consequences of Not Qualifying or Registering		107
		State Taxation of Foreign Corporations		107
	Filings for Employer			108
APPENDIX A CHARTS, FORMS & AGREEMENTS				110
	Summary of Key Differences Between Various Types of Business Entities			111
	Articles Of Incorporation (California Corporation)			113
	Bylaws (California Corporation)			115
	Organizational Board Resolutions			137
	Action Of Incorporator (California Corporation)			142
	Stock Ledger & Capitalization Summary			143
	Sample Resolutions Of The Board Of Directors			151
	Sample Stock Certificate (Common Stock)			156
	Sample Stock Certificate (Preferred Stock)			158
	Right Of First Refusal Agreement			160
	Promissory Note			166
	Employment Application			168
	Employee Offer Letter			173
	Assignment Agreement For Employee			175
	Stock Subscription Package			191
APPENDIX B FREQUENTLY ASKED QUESTIONS ABOUT CORPORATIONS				206
	How much does it cost to form a corporation?			206
	Do I need an attorney to form a corporation?			206
	In what state should I incorporate my corporation?			207
	Why would I form a corporation instead of a general partnership?			207
	Do I need a business plan to form a corporation?			208
	How can I raise money for my corporation?			209
	What is the role of officers and directors in a corporation?			209
	What kinds of taxes should I expect in connection with a corporation?			206
	Is it complicated to sell a corporation?			210
	What are the 5 most important steps to take in forming a corporation?			211
APPENDIX C ADDITIONAL RESOURCES				212
	Web Site Resources			212
	Search Engines and Directories			213
	Books			214
	Government			215
APPENDIX D SECRETARY OF STATE INFORMATION FOR INCORPORATING IN ALL STATES				218

The AllBusiness.com Practical Guide to Incorporation

Overview
Where to Incorporate
Limited Liability
Corporate Formalities
The Advantages and Disadvantages of a Corporation
Costs

---

Overview

Defined

A corporation is defined as a legal entity or structure created under the authority of the laws of a state consisting of a person or group of persons who become shareholders. The entity’s existence is considered separate and distinct from that of its members. Like a real person, a corporation can enter into contracts; sue and be sued; pay taxes separately from its owners; and do the other things necessary to conduct business. Since a corporation is an entity in its own right, it is liable for its own debts and obligations. As a result, providing that corporate formalities are followed, the corporation’s owners (the shareholders) typically enjoy limited liability and are legally shielded from the corporation’s liabilities and debts.

Life of a Corporation

The existence of a corporation is not dependent upon who the owners or investors are at any one time. Once formed, a corporation continues to exist as a separate entity even when shareholders die or sell their shares.

A corporation continues to exist until the shareholders decide to dissolve it or merge it with another business.

State Law

Corporations are subject to the laws of the state of incorporation and to the laws of any other state in which the corporation conducts business. Corporations may thus be subject to the laws of more than one state. All states have corporation statutes that set forth the ground rules as to how corporations are formed and maintained.

Where to Incorporate?

The laws governing corporations vary from state-to-state. As a result, a common question prior to incorporation is “Where should I incorporate?” The simple answer for the great majority of companies is that you should incorporate in the state in which your corporation intends to conduct the majority of its business. If you intend to do business in only one state, you should incorporate in that state.

Other Considerations

If you feel you might be interested in incorporating in a state other than the one in which your corporation will conduct the majority of its business, you will want to consider the following issues:

• What is the tax rate for the state(s) you are consideration for incorporation?
• What are the comparative costs of incorporation in a particular state versus the costs of registering to do business as a foreign corporation in that state?
• What are the corporate laws of the state with regard to the rights and responsibilities of corporate shareholders, officer, and directors?
• What are the corporate laws of the state regarding the rights of creditors?

When corporation laws were first being enacted by the states, several states purposely enacted laws to attract businesses to incorporate in their states even though the corporations would do business in other states. The first states in this group were New Jersey, Delaware, Maine, Arizona, and a few others. Today, Delaware is the clear winner. Close to one-half of all corporations listed on the New York Stock Exchange are incorporated in Delaware even though most of those corporations have their principal places of business elsewhere.

If you incorporate in one state and end up conducting most of your business in a different state, you will have to qualify to do business in that other state, which will involve more fees and costs, more filing requirements, and more paperwork. If your business actually conducts business in more than one state, or if it is a large, publicly held corporation, it can be worth the additional cost and time to incorporate in one state but operate in another state or states.

A corporation doing business in a state other than its state of incorporation is considered a foreign corporation. See Chapter 11 for a discussion about corporations qualifying to do business in states other than the state of incorporation.

Delaware

According to the Delaware Secretary of State, there are several reasons that so many companies choose to incorporate in Delaware:

• The Delaware General Corporation Law is one of the most advanced and flexible corporation statutes in the nation;
• Delaware courts and, the Court of Chancery in particular, have over 200 years of legal precedent as makers of corporation law;
• The state legislature takes its role seriously in keeping the corporation statute and other business laws current; and
• The office of the Secretary of State operates like a business rather than a government bureaucracy with modern systems and a customer-oriented staff.

The Delaware Court of Chancery has an excellent reputation and is predominantly a business law court. Its judges have a great deal of experience with business disputes. Other states have created similar specialty courts, but none have achieved quite the reputation of the Delaware Court of Chancery.

Highlights of benefits to incorporating in Delaware include:

• Low cost incorporation fees;
• No state corporation income tax for Delaware corporations not operating in Delaware;
• No name or address disclosure requirement for the initial board of directors;
• One person may hold all corporate offices;
• The corporation must have a registered agent in Delaware, but not a business office; and
• Claims relating to the corporation will be heard by the Delaware Court of Chancery.

It makes sense for a large, publicly held corporation to incorporate in Delaware. It also may make sense to incorporate in Delaware if your corporation will conduct business in more than one state. It does not, however, generally make sense for a small, privately held corporation that will only conduct business in another state to incorporate in Delaware.

If you are a California business only doing business in California, there will be extra costs and paperwork to be a Delaware corporation, and you should most likely choose to be a California corporation. But again, if you are only doing business in one state such as California, it will generally make more sense to be a California corporation.

Nevada

Nevada is another state attempting to attract businesses to incorporate there by enacting corporate-friendly laws. Some of the benefits of incorporating in Nevada include:

• Anonymity for stockholders by allowing stockholders to avoid having their names becoming part of the public record;
• Stockholders, directors, and officers may be nonresidents of Nevada;
• No state annual franchise tax;
• No state corporate tax on profits; and
• One person may hold all corporate officers.

But again, if you are only doing business in one state such as California, it will generally make more sense to be a California corporation.

Secretary of State

The Secretary of State is the official who is responsible for handling each state’s business filings. The office of the Secretary of State for each state is where you file the documents and paperwork, and pay fees to create, manage, and dissolve a corporation. The best way to obtain the most up-to-date filing and fee information regarding your corporation is to contact your state’s Secretary of State, first by visiting your state’s Secretary of State website. All states provide access to corporate filing information in this manner. Contact information for the Secretary of State for each state is set forth at the end of this book in Appendix D.

Limited Liability

Defined

One of the key advantages to forming a corporation as your business entity is that if it is properly formed and operated, creditors should not be able to successfully sue the corporation’s shareholders for their personal assets. This is what is known as limited liability. If something goes wrong, the shareholders will have only risked what they invested in the corporation and not their personal assets.

Exceptions

Shareholders’ personal assets are generally protected from creditors of the corporation. There are, however, certain circumstances in which limited liability will not protect those assets and a shareholder may be held personally liable, including possibly when:

• There is a disregard of corporate formalities;
• The shareholder personally injures someone;
• The shareholder personally guarantees a bank loan or business debt on which the corporation defaults;
• The shareholder neglects to deposit taxes withheld from employees’ wages;
• Personal and corporate assets are commingled;
• The corporation in inadequately capitalized; and
• Corporate assets and liabilities are manipulated by the shareholder(s).

Corporate Formalities

A corporation should follow proper corporate formalities in order to comply with applicable laws and to maintain its corporate existence. Any failure to follow these formalities might result in the loss of corporate status; loss of limited liability, leaving the owner and shareholders personally responsible for corporate debts; and potential loss of corporate tax benefits.

Corporate formalities fall into the following general categories:

• Shareholder and director meetings (annual and special);
• Signing documents as a corporation;
• Corporate record keeping (financial and corporate documents);
• State annual filings (corporate report, franchise tax, federal and state corporate tax);
• Bank accounts (separate corporate bank accounts); and
• Financial statements (income and cash flow).

A huge part of following proper corporate formalities is about creating and maintaining good records. The types of records you can be expected to keep for your corporation include the following:

• Accounting and bookkeeping records;
• Bank records;
• Contracts;
• Corporate records;
• Correspondence;
• Employee records;
• Business forms;
• Intellectual property records;
• Marketing and advertising records;
• Permits and licenses;
• Stock records; and
• Tax records.

Corporate formalities are discussed in detail in Chapter 8.

As you can see, there are many advantages and disadvantages of forming a corporation, and you should be aware of all of them in order to make an informed decision as to whether forming a corporation meets your business needs.

A chart summarizing the key differences between various types of business entities is included in Appendix A. The chart compares C corporations, S corporations, sole proprietorships, general partnerships, limited partnerships, and LLCs.

Costs

There are typically four types of costs for forming a simple corporation:

• Fling fees with the Secretary of State;
• First year franchise tax payment;
• Various governmental filings; and
• Attorney fees.

Filing Fees

Each state requires a fee to be included along with the incorporation papers. The filing fee may be set, may be based on the number of shares authorized, or be a combination of both. The highest filing fee of $300 is charged by Texas, with Alaska coming in at a close second at $250. Most filing fees range from $75-$125. See Chapter 3 for a discussion about Articles of Incorporation.

Franchise Tax Payment

A franchise tax is the fee paid for the privilege of doing business in a state. Not all states charge a franchise tax as an incentive for businesses. Nevada does not charge an annual franchise tax payment.

Government Filings

Two factors will determine the types of governmental filings for your corporation: the type of business; and the state of incorporation. See Chapters 7, 8, and 11 for discussions of the types of filings required for corporations.

Attorney Fees

Attorney fees is the cost that can vary the most when you incorporate and will depend on several factors: whether you are incorporating a simple corporation; whether you incorporate in the state in which your corporation conducts the majority of its business; whether the corporation can qualify for exemptions from federal and state securities laws; and, whether your corporation is involved in a heavily-regulated type of business.