How to Set Up a Close Corporation
A close corporation is a form of enterprise where the owner/shareholders are actively involved in the business affairs and management of the company. In order to insure that control remains with the select group of shareholders, certain documents need to be drafted at the inception stage of the corporation.
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Instructions
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Determine how many shareholders will be involved in the business. The corporation statutes of some jurisdictions limit the maximum number of allowable shareholders in a close corporation.
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Complete the Articles of Incorporation and file with the appropriate state agency (usually the Secretary of State's Office). Designate officers and directors, list the number of shares the corporation is authorized to issue, and note any stock transfer restrictions. If it is known that certain shareholders will not participate in the management of the corporation, it may be prudent to authorize the corporation to issue two classes of stock: voting and non-voting.
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Stipulate in the by-laws how officers and directors shall be elected, the duration of their terms, as well as the frequency of shareholder and any annual meetings. If desired, you can establish high quorum requirements for shareholder votes for extraordinary corporate transactions such as mergers and acquisitions.
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Draft necessary shareholder agreements and stock transfer restrictions. The most important aspect of organizing and operating a close corporation successfully is to draft shareholder agreements that define how and in what manner the corporation shall be managed and controlled by the shareholders.
Such agreements may provide for how the shareholders will vote their shares; how officers and directors shall be elected; how and when dividends will be distributed, and the details of any individual shareholder employment agreements with the corporation.
Since the primary purpose in establishing a close corporation is to retain control among the small group of designated shareholders, it is imperative that stock transfer restrictions be drafted so as to avoid inadvertent transfer of shares to outside, unaffiliated third parties.
The transfer restrictions should be specified in the Articles of Incorporation, incorporated in any shareholder agreements, as well as conspicuously noted on the physical share certificates themselves Complying with the notice provisions insures that any subsequent owner of the shares takes them subject to the specified restrictions.
Stock transfer restrictions may also include either a right of first refusal option with the corporation, or a mandatory buy-out or redemption provision, in cases where a shareholder dies or wishes to leave the enterprise.
Since shares in a close corporation are privately held and not traded on any stock exchange, in order to avoid disputes when mandatory buy-out or stock redemption provisions are triggered, shareholders would be wise to agree in advance for a methodology for valuing the shares. This can be accomplished by jointly naming a neutral third party (arbitrator or business appraisal expert) who will conduct a fair share price assessment.
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Tips & Warnings
Specific requirements for both establishing and preserving the organization's status as a close corporation vary from state to state. Consult with an attorney to insure compliance.
