Corporations are controlled primarily by state, not federal, law. This means that 50 different sets of rules cover how corporations are created. Terminology differs from state to state. For example, most states use the term articles of incorporation to refer to the basic document creating the corporation, but some states (including Connecticut, Delaware, New Jersey, New York, and Oklahoma) use the term certificate of incorporation. Tennessee calls it a charter and Massachusetts uses the term articles of organization. Fortunately, the similarities in corporate procedure outweigh the differences. Nevertheless, watch out for the differences.
People involved in a corporation traditionally play different legal roles: incorporator, shareholder, director, officer, employee. And, in virtually every state, there’s a way that you can set up a corporation in which one or two people play all roles.
The incorporators (called the promoters in some states) do the preparatory work. This may include bringing together the people and the money to create the corporation. It always includes preparing and filing the articles of incorporation—the formal incorporation document that is filed with a state office, such as the secretary of state. Although several people can serve as incorporators and sign the articles of incorporation, only one incorporator is required by law. Once the articles of incorporation are filed, the incorporator’s job is nearly done. The only remaining tasks are to select the first board of directors and to adopt the corporate bylaws (although, in some states, bylaws may be adopted by the directors).
The shareholders own the stock of the corporation. One person can own 100% of the stock. Among other things, shareholders can:
• elect directors (although the initial board of directors is usually selected by the incorporator)
• amend bylaws
• approve the sale of all or substantially all of the corporate assets
• approve mergers and reorganizations
• amend the articles of incorporation
• remove directors, and
• dissolve the corporation.
State laws typically require that the shareholders hold an annual meeting. However, in many states, a consent action or consent resolution—a document signed by all of the shareholders—can be used in place of a formal meeting. For the corporation to elect S corporation status under federal tax laws, all shareholders must sign the election form that’s filed with the IRS.
The directors manage the corporation and make major policy decisions. Directors authorize the issuance of stock, decide on whether to mortgage, sell, or lease real estate, and elect the corporate officers. Directors may hold regular or special meetings (or both). However, in many states, it’s simpler and just as effective for the directors to take actions by signing a document called a consent resolution or consent action.
The incorporators or shareholders decide how many directors the corporation will have. The number of directors is usually stated in the articles of incorporation or in the corporate bylaws. Most states specifically permit corporations to have just one director. In the remaining states, the requirement is that there be at least three directors, but there’s an exception for corporations with fewer than three shareholders. If there are only two shareholders, the corporation can operate with two directors; if there’s only one shareholder, the corporation needs only one director.
Example: Anita, Barry, and Clint create a corporation in Michigan. They choose Anita to be the sole director. They can do this because the law in Michigan—as in many other states—permits a corporation to function with a single director regardless of the number of shareholders.
Example: Dustin, Erwin, and Faye create a corporation in California. They would like Dustin to be the sole director, but California law requires them to have at least three directors if there are three or more shareholders. Therefore, Dustin, Erwin, and Faye create a three-person board of directors and appoint themselves to those positions.
The officers are normally responsible for the day-to-day operation of the corporation. State laws usually require that the corporation have at least a president, secretary, and treasurer. The president is usually the chief operating officer of the corporation. The secretary is responsible for the corporate records. The treasurer, of course, is responsible for the corporate finances, although it’s common to hand day-to-day duties to a bookkeeper. The corporation can have other officers—such as a vice president—as well. In most states, one person can hold all of the required offices.
Example: Abdul forms a Texas corporation. He provides for the two corporate offices—president and secretary—that are required by Texas law. He appoints himself to both offices. This is legal in Texas and in most other states.
Employees work for the corporation in return for compensation. In small corporations, the owners (shareholders) are usually also employees of the corporation. As a corporate employee, it’s through your salary and other compensation that you’ll receive most of your financial benefits from the business. Often the person who runs the business day-to-day gets the most compensation. This may or may not be the president.
Excerpted from Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo).