California’s Close Corporation Rules: How to Form One, When It Makes Sense, and How It Stacks Up Against an LLC

If you practice in California long enough, you see the same pattern: two or three founders form a “plain vanilla” corporation with boilerplate bylaws, issue some common stock, and only later realize they actually wanted a tightly held, non-transferable, partnership-style structure. At that point you’re reverse-engineering restrictions, buy-sell rights, and unanimous-consent deals after people have already married, divorced, died, or fallen out.

The California close corporation is the statutory tool built for that use case. Properly set up, it gives you:

• The liability shield and tax options of a corporation (including S-corp status),

• A hard cap on the shareholder circle (35 record holders or fewer), and

• The ability to run the business through shareholder agreements that look more like a partnership or LLC operating agreement than traditional corporate governance.

This article walks through when a California close corporation is the right vehicle, how to form one, how transfer restrictions and unanimous shareholder agreements fit into the structure, and how it compares to simply using an LLC.

1. What is a California “close corporation”?

California Corporations Code § 158 defines a “close corporation” essentially as:

• A corporation whose articles contain a specific close-corporation statement,

• With no more than 35 shareholders of record, and

• Whose shares are subject to transfer restrictions and cannot be offered to the public.

A close corporation is still a stock corporation. It files the same Articles with the Secretary of State (using ARTS-GS or custom articles), pays the same Franchise Tax Board minimum tax ($800), and chooses its tax status (C-corp by default, S-corp by election).

What’s different is the internal governance regime permitted under Corporations Code § 300(b) and related provisions:

• Shareholders can, by written agreement, dispense with or substantially limit the board of directors and manage the corporation more like partners.

• Unanimous shareholder agreements can validly allocate decision-making and veto rights that would be impermissible in an ordinary public-style corporation.

• Shares are typically subject to rigid transfer restrictions, keeping the ownership group frozen unless everyone consents to changes.

Think of it as a statutory overlay that lets you dial a corporation toward a partnership/LLC feel, while staying inside the corporate tax and liability box.

2. When a California close corporation makes sense

Close corporations are not for everyone. They’re best when the business plan and cap table are intentionally small and stable.

Good candidates

1. Family businesses and tightly held operating companies

   Two siblings, a married couple, or a parent-child team running a closely held operating company (retail, agency, small manufacturing, consulting, niche SaaS, etc.) often benefit from:

   • A single corporate wrapper,

   • Predictable S-corp payroll/dividend economics, and

   • Hardwired transfer restrictions so no one wakes up with an ex-spouse or cousin as a co-owner.

2. Professional or quasi-professional practices that can’t or don’t want to use an LLC

   Some professions in California are either barred from using LLCs/PLLCs or find banks and regulators more comfortable with corporations. Where a formal “professional corporation” (PC) is not required, a close corporation can:

   • Mimic tight partnership economics, and

   • Still satisfy regulators, landlords, or payers who expect a corporate entity.

3. Lifestyle businesses with no VC ambitions

   If the founders have no realistic plan to:

   • Raise institutional venture capital,

   • Grant options to dozens of employees, or

   • Go public,

   then imposing a 35-shareholder cap and strong transfer restrictions is often a feature, not a bug.

4. Situations where unanimity is a virtue, not a bug

   Some groups genuinely want “all for one, one for all” governance:

   • Major decisions (sale, new partner, big debt) require unanimous consent;

   • Founders want powerful veto rights and are not afraid of deadlock because they are few, aligned, and can live with exit mechanisms in the documents.

   This is where the statutory close corporation shines: it openly contemplates shareholder-level management arrangements that would be awkward or risky in a publicly-oriented corporate form.

Poor candidates

1. Anything with venture or angel-portfolio aspirations

   If the business plan includes:

   • Institutional VC,

   • Angel portfolios expecting a standard Delaware C-corp,

   • Option pools covering 10–20+ employees,

   then the close-corporation regime is the wrong tool. Investors will insist on a plain C-corp, usually Delaware, with no close-corporation gimmicks or 35-holder caps that complicate cap tables.

2. Cap tables that will quickly exceed 35 shareholders

   Remember the 35-holder ceiling includes anyone who holds shares of record (subject to some aggregation rules). If the plan is to:

   • Broadly distribute stock/RSUs to staff,

   • Run a crowdfunding raise,

   • Or coordinate a large ESOP,

   you’ll blow through the limit. Better to start with a standard corporation.

3. Complex cross-ownership webs

   If the intended equity holders include:

   • Other entities (funds, holding companies),

   • Non-U.S. persons where S-corp is desired,

   • or tax-sensitive investors,

   you may be better off with an LLC or a standard corporation plus carefully structured shareholder agreements.

3. Basic mechanics: how to form a California close corporation

The state doesn’t have a separate “close corporation” formation form. You form a stock corporation and elect close-corporation status in the Articles of Incorporation.

Step 1: Decide on your tax posture (C vs. S)

Before drafting anything, align the owners on tax status:

• C-corp (default)
  Subject to entity-level tax (8.84% in California plus federal 21%), then dividends taxed again at shareholder level. Useful if you plan to retain earnings or pursue QSBS benefits down the line.

• S-corp (by IRS Form 2553 election)
  Pass-through for federal and (in CA) 1.5% franchise tax on net income, plus $800 minimum. Shareholder-employees draw W-2 salary plus distributions.
  S-corps require:

  • Only allowable shareholders (individuals, certain trusts; no non-resident aliens, no entities), and

  • Only one class of stock (voting and non-voting is fine; no preferred).

A California close corporation can be either C or S; “close” is state corporate law, not a tax classification. For the typical small closely held business, a California close S-corp is the common configuration.

Step 2: Draft Articles of Incorporation with close-corporation language

Use the Articles of Incorporation for a general stock corporation (ARTS-GS via BizFile Online) or a custom Articles template, but insert:

1. A clause electing close-corporation status under Corporations Code § 158 / § 300(b), typically along the lines of:

   “This corporation is a close corporation. All of the issued shares of this corporation shall be held of record by not more than 35 persons, and the corporation shall not make any offering of its shares to the public.”

2. A statement that the corporation is authorized to operate as a close corporation and that any transfer of shares in violation of the transfer and shareholder-number restrictions is void or subject to redemption.

3. Optional but recommended: a cross-reference to the shareholder agreement, for example:

   “The management and affairs of the corporation may be governed, in whole or in part, by a written agreement among all of the shareholders as authorized by Corporations Code § 300(b). Any such agreement shall be binding on the corporation and all shareholders, including transferees with notice thereof.”

You still include the usual items:

• Corporate name (with “Inc.”, “Corporation”, “Company” or similar),

• Authorized shares (number and par value or “no par”),

• Agent for service of process,

• Initial business address.

Step 3: File with the California Secretary of State

File Articles via BizFile Online:

• Filing fee: currently $100 for for-profit corporations.

• Processing time: often 2–4 business days for straightforward online filings.

On approval you receive:

• A file-stamped copy of the Articles,

• An entity number.

At this point you have a corporation on record. Close-corporation status is in place because of the Articles language, but you still need to build the governance and transfer-restriction infrastructure.

Step 4: Organizational meeting, bylaws, and initial issuances

At the organizational meeting (or by unanimous written consent):

1. Adopt bylaws.

   For a close corporation, you want bylaws that:

   • Recognize that certain management powers may be exercised by shareholders under § 300(b),

   • Coordinate with your unanimous shareholder agreement (USA),

   • Enforce transfer restrictions (right of first refusal, mandatory buy-sell, consent requirements),

   • Address what happens if the 35-shareholder limit is threatened.

2. Elect the board (if you’re keeping one).

   You can:

   • Maintain a conventional board with defined powers, and

   • Use the shareholder agreement to reserve major decisions to the shareholders or require unanimity.

   Alternatively, § 300(b) allows eliminating or severely limiting the board if all shareholders agree, but you want to be intentional—banks, landlords and outsiders often expect someone to have clear authority to sign.

3. Appoint officers.

   President/CEO, Secretary, Treasurer/CFO at minimum. In a micro-company one person can hold all three.

4. Authorize share issuances.

   Approve:

   • Number of shares per founder,

   • Consideration (cash, IP assignment, services),

   • Any vesting (for example restricted stock vesting over time),

   • Legends to be printed on certificates.

5. Issue stock and update the stock ledger.

   Deliver certificates (physical or electronic) with legends noting:

   • Close-corporation status,

   • Transfer restrictions,

   • Reference to the USA or buy-sell agreement,

   • S-corp limitation language if applicable (“The shares represented by this certificate may not be transferred to any person who is not an eligible S corporation shareholder…”).

Step 5: File Statement of Information and obtain EIN

Within 90 days of filing Articles:

• File Statement of Information (SI-350) listing:

  • Officers,

  • Directors,

  • Addresses,

  • Agent.

Simultaneously:

• Obtain EIN from the IRS (online SS-4).

• Open corporate bank account in the corporation’s name.

• Register with the Franchise Tax Board and calendar the $800 minimum tax and return filing dates.

Step 6: Prepare and sign the unanimous shareholder agreement

For a close corporation, the USA is where you solve most of the real business issues:

• Who can come in or out as an owner?

• What happens on death, disability, divorce, default, or deadlock?

• Who decides on major events (sale, merger, large loans, new line of business)?

• How are salaries, profits, and distributions set?

More detail on the USA below; conceptually, you want all existing shareholders to sign it, and you want every new shareholder to sign a joinder as a condition of receiving shares.

Step 7: Maintain close-corporation status over time

After formation, you preserve close-corporation status by:

• Keeping no more than 35 shareholders of record,

• Continuing to honor transfer restrictions and obtain joinders,

• Ensuring the Articles’ close-corporation language remains in place (no amendments dropping it without the level of shareholder approval required under the Corporations Code and the USA),

• Avoiding any public offering of shares—no general solicitation or advertising, stay within private-offering exemptions.

If you breach the requirements (for example by transferring shares to a 36th shareholder of record), you can lose close-corporation status and fall back to being a standard corporation, which can create governance and tax headaches if your documentation assumed a close-corp regime.

4. Transfer restrictions: keeping the circle small

The hallmark of a close corporation is that shares do not move freely. Restrictions serve several purposes:

• Preserve close-corporation status (≤ 35 shareholders),

• Preserve S-corp eligibility (where chosen),

• Keep unwanted outsiders from becoming co-owners,

• Provide liquidity and exit paths for founders without forcing a fire sale.

Typical tools:

Right of first refusal (ROFR)

If a shareholder receives a third-party offer for their shares, they must first offer those shares to the corporation and/or other shareholders on the same terms.

Key drafting points:

• Who has the first bite—corporation or other shareholders?

• Allocation method among multiple buyers (pro rata, first-come, etc.).

• Timelines for notice, acceptance, and closing.

ROFR is a gate-keeping device; it doesn’t force anyone to buy, but it prevents a shareholder from selling to an outsider without giving insiders a chance to keep ownership in the family.

Mandatory buy-sell (triggered redemptions)

Certain events automatically trigger a mandatory sale or redemption of a shareholder’s stock, usually at a contractually defined price or valuation formula:

• Death,

• Permanent disability,

• Termination of employment,

• Bankruptcy or insolvency,

• Divorce (if shares are at risk of being awarded to a non-party spouse),

• Material breach of the USA.

You then specify:

• Whether the corporation, remaining shareholders, or both have the purchase obligation/right,

• How the purchase price is determined (appraisal, formula, agreed value updated annually),

• Payment terms (cash up front vs. promissory note with security).

Consent / approval rights

Transfers that are not triggered by a buy-sell event may require:

• Approval of the board,

• Approval of a defined supermajority of shareholders (e.g., 2/3 or 75%),

• Unanimous consent.

For example, transfers into trust, to an estate-planning vehicle, or to certain family members might be allowed with board approval so long as they don’t violate S-corp rules or push you above 35 shareholders.

S-corp eligibility restrictions

If you elected S-corp status, you must make sure your restriction set:

• Prohibits transfers to non-resident aliens, corporations, partnerships, and most trusts,

• Requires any permitted trust transferees to be qualified (QSST or ESBT) and the necessary elections to be filed,

• Treats any invalid transfer as void or subject to automatic redemption before it can blow the S election.

These points belong both in the USA and on the certificate legends so transferees are on notice.

5. The unanimous shareholder agreement: running a corporation like a partnership

Corporations Code § 300(b) specifically contemplates that all shareholders of a close corporation can agree in writing to manage the corporation in ways that depart from the default board-centric model.

Properly used, a USA lets you:

• Allocate management powers between the board and shareholders,

• Give individuals or groups blocking rights over major decisions,

• Define dispute-resolution and buy-out mechanisms,

• Hard-wire long-term planning into the company’s DNA.

Key components usually include:

Decision-making and veto rights

You can define:

• Day-to-day authority (often delegated to officers),

• Matters reserved to the board,

• “Major decisions” that require:

  • Unanimous shareholder approval, or

  • A high supermajority (e.g., 80%).

Examples of major decisions:

• Issuing new shares or admitting a new shareholder,

• Amending Articles, bylaws, or the USA,

• Selling all or substantially all assets,

• Merging or consolidating with another company,

• Incurring debt above a defined threshold,

• Changing the nature of the business,

• Increasing or decreasing authorized shares.

Employment and compensation expectations

In a two- or three-founder close corporation, a lot of friction comes from:

• One founder working full-time while another drifts,

• Disagreements over salaries vs. distributions.

The USA can:

• Define founder roles and minimum time commitments,

• Set baseline salaries or a mechanism for adjusting compensation (for example, board or unanimous shareholder approval),

• Specify how and when profits will be distributed.

Buy-sell and exit mechanisms

Beyond the transfer restrictions already discussed, a good USA includes:

• Voluntary exit rules: how a shareholder can sell out, at what valuation, and with what consent.

• Deadlock resolution: for 50/50 companies, mechanisms like:

  • “Russian roulette” or “Texas shoot-out” buy-sell procedures,

  • Third-party tie-breaker votes for specific issues,

  • Put/call options after a cooling-off period.

• Drag-along / tag-along rights:

  • Drag-along: if a defined majority agrees to sell the company, minority holders must sell on the same terms.

  • Tag-along: if a controlling shareholder sells shares, minority holders can “tag along” and sell pro rata to the same buyer.

Duration, amendments, and notice

To keep the USA enforceable:

• Make it unanimous at inception (all shareholders sign).

• Require any amendment to be unanimous (or at least as strict as the statute demands for governance-changing agreements).

• Require that:

  • A legend on each share certificate references the USA, and

  • New shareholders sign a joinder agreement as a condition to any transfer.

Without these steps, transferees may argue they took shares without notice of the USA and are not bound by it.

6. California close corporation vs. LLC

Many small businesses face the choice: close S-corp or multi-member LLC. Each has a coherent use case.

Where the close corporation has the edge

1. S-corp payroll tax arbitrage (for active owners)

   For owner-operators, an S-corporation can:

   • Pay a “reasonable salary” (subject to payroll taxes), and

   • Distribute additional profit as S-corp dividends (not subject to Social Security/Medicare self-employment tax).

   LLC members in a service business are often treated as self-employed for FICA/FUTA unless special structures are used, which reduces this arbitrage.

2. Bank and third-party familiarity

   Many lenders, landlords, and small-business counterparties still understand corporations better than LLCs, especially outside of tech/real estate. Documents, covenants, and signatures are often smoother with a straightforward corporate structure.

3. Equity comp and eventual institutional interest

   If there is a non-zero chance that the business could:

   • Eventually raise money from conventional investors, or

   • Adopt even a small stock-option plan,

   starting with a corporation (even a close S-corp) avoids a future LLC-to-C-corp conversion.

4. State tax profile at higher revenue levels

   In California, LLCs pay:

   • The $800 annual LLC tax, plus

   • A gross-receipts-based fee once revenue exceeds relatively low thresholds.

   Corporations pay:

   • $800 minimum franchise tax, plus

   • 1.5% (S-corp) or 8.84% (C-corp) on net income.

   At certain revenue/profit mixes, the LLC fee is heavier than the corporate regime.

Where the LLC has the edge

1. Flexibility in economics

   LLCs can:

   • Allocate profits and losses in ways divorced from capital contributions (subject to substantial-economic-effect rules),

   • Create profits interests and different classes of units with bespoke economics,

   without running into S-corp’s “one class of stock” rule.

2. Fewer corporate formalities

   While you still want records, an LLC generally has fewer statutory formalities:

   • No annual shareholder meetings or minutes,

   • No corporate “board” unless you choose to have one.

   For some founders this is a cultural fit.

3. No close-corporation structural traps

   LLCs don’t have:

   • A hard 35-member cap,

   • The same risk of accidentally losing a statutory status by issuing one too many membership interests.

   You implement tight transfer restrictions in the operating agreement, but you’re not balancing statutory caps.

4. Better for passive or complex investor pools

   LLCs easily accommodate:

   • Entity members (funds, corporations),

   • Foreign investors,

   • Special allocations.

   An S-corp cannot.

Choosing between them

A quick rule of thumb:

• If you have a small, active group of U.S. individual owners, want S-corp payroll economics, anticipate no non-individual investors, and prefer corporate optics → California close S-corp is a strong candidate.

• If you want maximum flexibility in future investors, no hard cap on owners, and custom economics → LLC is more forgiving.

7. Converting in and out of close-corporation status

From standard corporation to close corporation

If a company starts life as a regular California stock corporation, you can later elect close-corporation status by:

1. Amending the Articles to add the close-corporation language (subject to the Corporations Code’s approval thresholds), and

2. Ensuring that all shareholders consent if required and that the 35-holder and transfer-restriction requirements will be satisfied.

Practically, you want unanimous shareholder approval when converting to a close corporation, because you are fundamentally altering transferability and governance expectations.

From close corporation to standard corporation

You can also drop the close-corporation language by amending Articles, but:

• The Corporations Code may require unanimous shareholder consent or very high thresholds depending on how governance is structured,

• Your USA and bylaws will need revision,

• You must consider tax and securities-law impacts of opening up the cap table.

This usually happens when:

• The business is ready for outside investors, or

• The shareholder group grows beyond the close-corporation model.

8. Common traps and practical tips

1. Ignoring certificate legends and joinders

   If new shareholders get certificates (or book-entry notices) that don’t mention the close-corporation status and the USA, they can argue that they took free of those restrictions. Always:

   • Include proper legends, and

   • Require a signed joinder before any transfer is recorded.

2. Accidentally creating a 36th shareholder

   Track share issuances carefully. A casual issuance to a friend, family member, or advisor without consolidation rules can push you over the 35-holder limit.

3. Violating S-corp eligibility

   Letting a foreign investor or entity become a shareholder in an S-corp—even accidentally—can terminate the S election. Your restriction set should treat such transfers as:

   • Void, or

   • Immediately redeemable at a pre-set price.

4. Assuming the USA automatically binds spouses and future parties

   In community-property states and in divorce contexts, you may need:

   • Spousal consents acknowledging the USA and agreeing to be bound,

   • Clear language that any award of shares to a non-party spouse triggers a mandatory repurchase.

5. Relying on handshake expectations

   Founders often believe “we trust each other” is enough. The whole point of the close-corporation regime is to convert that trust into written, enforceable constraints before things change.

9. Practical checklist for forming a California close corporation

For a small, closely held company where a California close corporation makes sense, the workflow is roughly:

1. Align founders on:

   • Tax status (C vs. S),

   • Long-term ownership vision (number and type of shareholders),

   • Desired governance style (board-centric vs. partnership-style).

2. Draft Articles that:

   • Elect close-corporation status,

   • Cap shareholders at 35,

   • Prohibit public offerings,

   • Reference the USA.

3. File Articles via BizFile, obtain entity number, calendar the Statement of Information.

4. Hold the organizational meeting:

   • Adopt close-corporation-optimized bylaws,

   • Elect board and officers,

   • Authorize share issuances,

   • Approve initial USA form.

5. Obtain EIN, open bank account, set up FTB profile, file IRS Form 2553 if S-corp status is desired.

6. Finalize and sign the unanimous shareholder agreement:

   • Transfer restrictions and buy-sell triggers,

   • Decision-making and veto rights,

   • Employment/compensation expectations,

   • Deadlock resolution and exit mechanisms.

7. Issue stock with proper legends and collect joinders from all shareholders (and spousal consents where appropriate).

8. Maintain status:

   • Monitor shareholder count,

   • Enforce transfer restrictions,

   • Update USA and bylaws only with proper consent levels,

   • Track taxes and filings.

Done right, the California close corporation combines a compact, tightly controlled cap table with familiar corporate optics and LLC-like flexibility in governance, making it an excellent default for serious but non-VC small companies.