How to choose the right entity for your new California business

On Behalf of | Sep 5, 2020 | Firm News |

Most northern California entrepreneurs realize that they should formally organize their business, but they are overwhelmed by choices when it comes to deciding in choosing a specific entity. The website of the California Secretary of State lists six different types of business entities, but it does not offer much guidance about which form is best for a particular kind of business.

The only specific choice is made for firms that practice law, accountancy, architecture or land surveying. These types of businesses must use the limited liability partnership. An LLP must maintain certain types of books and records, and the conduct of their businesses is also regulated by a public board that issues licenses to practice the profession and has the power to disqualify an individual from engaging in the business if the person has violated one or more of the board’s regulations.

The basic reason for using a corporation or limited liability partnership to run a business is twofold: (1) the ability to raise capital without placing personal assets at risk and (2) to protect the owners from unlimited liability for the obligations of the business. All business entities in California meet these two goals to varying degrees, but they have significant differences in how they are managed.

A business corporation is owned by its shareholders, who may own significantly different proportions of the company’s capital stock. The business is run by a board of directors elected by the shareholders. Directors hire the officers and approve most large business transactions, including borrowing money and purchasing or leasing facilities for the business. In small corporations, a shareholders may serve on the board and as an officer. Many small firms have a small board, consisting of a handful of members who may or may not be shareholders. Larger corporations may have a larger number of directors. The choice of the number of directors is one of the important decisions that must be made by the company’s founders.

Similar questions face owners of limited liability companies and limited partnerships. In these entities, some of the partners are shielded from general liability while others have only unlimited exposure for the entity’s obligations. LLC’s are generally run by a board of managers. The board of managers may appoint officers to manage the business. Limited Liability Partnerships are commonly used to finance real estate developments by selling a sizeable number of limited partnership interests while only a few investors manage the business. A limited liability partnership must have at least one general partner who is personally liable for the LP’s obligations; the liability of the limited partners is restricted to the amount of money that they paid for their interests.

At this point, the available choices for corporate and partnership organization diverge widely. Organizational issues such as signing non-disclosure agreements, allocation of percentages of ownership are usually decided at this moment, although most of these choices may be altered at a later date.

Any business may be easily organized by obtaining the necessary forms from the Secretary of State’s office, but as noted above, using these forms without first securing legal advice can result in unpleasant circumstances for the owners of the business once it begins operations. A far better course of action is to consult an experienced business attorney before beginning the organizational process. A knowledgeable business lawyer can identify potential pitfalls for various ownership schemes and can often suggest organizational forms that will ultimately save the owners a significant amount of money in income and property taxes.