Should Your Small Business Incorporate In California?
A question I get asked a lot by small business owners or prospective entrepreneurs is if they are starting a business whether or not you should incorporate in California. And if the answer is yes, they must next choose between a dizzying array of options: corporation, LLC, sole proprietorship, partnership? Just looking at the various business entities to choose from can cause confusion a prospective business owner. The number one reason to incorporate(or form a limited liability business entity) is to shield your family’s assets from your business activities. The court recognizes an entity as a legally separate entity; therefore typically its shareholders are not personally liable for the debts and obligations of a corporation. If your business fails, and you did not incorporate in California, your family’s house, car and other assets would not be used to pay off those debts that are owed. There are many exceptions of course, such as when you have to personally guarantee loans. But this is generally why business owners should definitely look to incorporate in California.
Other advantages include tax advantages.
Also, it is easier to transfer ownership, there is perpetual existence (the entity does not die when its owners do), and you can raise capital easier and faster if you incorporate in California. Disadvantages include double taxation in the case of some corporations (but not most small businesses), there are increased costs to start up and more costs to maintain the entity, and in some cases corporate formalities may be burdensome. Which entity does a small business owner choose when they incorporate in California? That question depends entirely on individual circumstances and should be determined on a case by case basis if you want to do this correctly. There are Corporations, California Close Corporations, both of which you can choose to treat as a C Corporation or an S Corporation where income or losses is passed through to the owners of the company, i.e. its shareholders. Don’t forget about Limited Liability Companies and Limited Partnerships. For some professionally licensed individuals, there are also Professional Corporations as well as Limited Liability Partnerships. The rules dictate when these MUST be used. It is not an easy thing to do to just incorporate in California, you must be well aware of the many options and pitfalls and advantages of each option.
As you can see there are many entities to choose from when you decide to incorporate in California and the decision should not be made lightly. A business owner should always consider choosing an entity that limits liabilit, because operating as a normal partnership or sole proprietorship will expose you, the business owner, to personal liability which is never desirable when you incorporate in California. After you incorporate in California you MUST ensure your Business is adequately capitalized. Whether or not your corporation is sufficiently capitalized is a factor that courts consider when they are determining whether or not they should apply what’s called “alter ego” liability (whereby the corporation is used as an alter ego for your personal matters). While it isn’t clear if undercapitalization by itself is sufficient for the court to pierce the corporate veil (punch a hole in the limited liability shield of entities) after you incorporate in California, you should take care to avoid adding undercapitalizing to a group of factors supporting such a finding. Or else you will risk having to incorporate in California for nothing.
So what constitutes adequate capitalization when you decide to incorporate?
The corporation must be capitalized, shortly after you incorporate in California, in an amount that is sufficient funds for the corporation to have “independent substance” in relation to third party obligations likely to be incurred. What this means is the initial shareholders should make a good faith effort to sufficiently capitalize the corporation with enough assets (through issuing capital shares or incurring debt) necessary to reach its break-even point. As long as the estimates made at the beginning are reasonable and in good-faith, shareholders should be able to avoid alter ego liability even if those estimates turn out to be wrong. Just a little work goes a long way at the beginning when you first started to incorporate in California.
What are your goals after you incorporate?
So when you take the first step after you decide to incorporate in California, you need to really think about what it is exactly you want to accomplish. What are the goals of your business? Where do you want to take the business? If you plan on doing some consulting on the side, have adequate insurance, and are not worried about any lawsuits for business debts then perhaps you aren’t ready to form a corporation or LLC. But if you want to have a solid business where you want to expand, invite outside investors, deal with big money contracts and deals, and want to be able to sleep at night, then you should sit down with an attorney who will guide you through the process to incorporate in California.
Sit down with a small business attorney who will help guide you through while you incorporate in California.