You’re about to start a business or maybe you already have an existing one. Someone tells you, “You need to incorporate in California! You need to form an S-corp! You need to form an LLC!”

All of this talk has you confused. So many different acronyms, so many entity choices to choose from, when you incorporate in California how do you decide? First you need to understand the differences between an LLC and a corporation. Then you need to look at the specific facts surrounding your business. Than you should consult with legal and tax professionals. Only then can the best decision be made.

When you incorporate in California you file an articles of incorporation. When you start an LLC you file articles of organization. The expense and difficulty is not that much higher than a corporation, depending on how many members there are, what duties rights each will get, and other complicating factors.

Asset protection/limited liability is for the most part similar across the two entity choices. They are not exactly the same but for this discussion we can assume they are mostly.

Where the LLC is advantageous compared to when you incorporate in California, is the flexibility involved. You can manage the company yourself, or delegate this to a hired manager. If you want to raise capital, then you can with an LLC, however it is much easier if you incorporate in California because then you’ll have to opportunity to sell shares as opposed to membership interests which is what ownership interests of LLC’s are called.

LLC’s are a blended form of entity. It is as if you were incorporate in California, as well as form a partnership in California. It almost takes the best of both worlds and combines them into one. You get asset protection as if you did incorporate in California, and you get less formalities and complications as if you formed a partnership.

Be careful though, if you are a single owner there are questions about how much protection an LLC has as opposed to the situation where you incorporate in California. Some think that a single member LLC will not provide asset protection. This is debatable but worth keeping in mind and keeping an eye on.

The LLC can be taxed in two ways. One way is as if the LLC doesn’t exist. Taxes are calculated, but the LLC doesn’t pay any taxes. Instead it is “passed through” to the underlying owners, you and whoever else. Or you can elect to treat it as a corporation for tax purposes. So you can make an election, and pretend you did incorporate in California and pay under the exact system California corporations do.

State taxes are also different. While there is no “income” tax there is a revenue tax. So in certain situations, forming an LLC maybe better than if you incorporate in California. There are other situations where that is switched.

So you must decide based on your own facts if you should incorporate in California, or form an LLC

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Incorporate In California – Factors

Risk - If your company has very low risk, perhaps you don’t need to incorporate in California. Although any one (or company) can be sued for any amount at any time, there are certain companies that don’t need to form a corporation. Perhaps you teach piano lessons a few times a week, and have no major assets. You are not a candidate to incorporate in California. Maybe you have a part time hobby that you run on the side. Insurance products may be an easier option for you.

Future Expansion – Do you plan on expanding your business in the future? If so, you may be a small company today, but if you incorporate in California today, it’ll be a much easier process than if you wait until you are expanding to do so. The easiest time to form a corporation is at the very beginning before any business has been conducted.

Partners, investors and Venture Capital - Do you have grand plans for your company? Do you plan on having partners, or small investors? Then you may be a perfect candidate. However, if you have enormous plans and are trying to attract serious venture capital, maybe you shouldn’t incorporate in California and perhaps should be looking at Delaware instead. But if you are going to be a regional/local company, then a normal corporation here is perfect. Most investors will want to see some sort of entity when investing in a business. After all, they don’t want to be personally liable for debts and obligations of the company, neither do you.

Tax advantages – If you incorporate in California, you will enjoy certain privileges when it comes to tax returns on corporations. For example you can fringe benefits can be provided to employees. You can also save some FICA/employment taxes with a corporation form. This will not apply in all situations but some.

Family – Do you have a family? Do you have a significant amount of family assets? If so, you should definitely incorporate in California. You need to protect your family’s assets. You should protect your family from your business’ activities. Imagine the scenario where your business fails, and in doing so you are sued for those debts and are held personally liable. That is a doomsday/nightmare scenario that nobody wants to even talk about forget about imagining it.

After reviewing the above factors, are you the perfect candidate to incorporate in California?

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By now you have read the reasons why you should incorporate in California. Mainly, a corporation will protect your family from your business activities. If your business is sued for any reason, all of your personal and family assets will be at risk if you have not formed a corporation or limited liability company. If you incorporate in California, and properly maintain it, your family’s assets will be protected.

So what steps must you take to form a corporation? It depends on whether you want to do this by yourself, with the help of a document preparation company, or a lawyer.

You see, all the steps to incorporate in California is the same. Whichever of the above you choose determines how much of it you have to do, and how much other people will do for you. If you choose to incorporate by yourself, it’s obvious you have to do it yourself. If you choose a lawyer, all the steps should be done by that lawyer, all based on your input.

At this point you are probably waiting for me to give you all the steps so you can take your business and incorporate in California. Every business is different, so this list can and will change depending on the unique circumstances surrounding every business. This list isn’t 100% complete but is a general checklist of the major items.

Steps to Incorporate in California

First you must determine whether or not you even need to incorporate in California. Some businesses  probably can get by without ever forming a proper business entity. These are real small businesses, low risk (but still some risk). Maybe really low transaction rates.

Next you must determine which type of entity you will choose when you incorporate in California. There are several choices. A corporation, a limited liability company, limited partnership, limited liability partnership, general partnership. This choice will depend on the specific facts and circumstances surrounding your business and family.

After that you must file the necessary documents with the Secretary of State to incorporate in California. Once you receive the approved documents then you must hold the initial meetings, establish bylaws, keep minutes and start building your corporate book. Then there are securities filings. Then you have to start looking at tax issues, such as subchapter S tax treatment from the IRS, apply for a tax identification number.

Local items include updating fictitious business name filings, business licenses, leases, contracts and other obligations that my have to be cleared first.

If you decide to incorporate in California just be aware of the vast requirements and steps to do so.

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So you decided to incorporate in California and you think you full protection of the corporation, shielding all of your personal and family assets, including your home, your cars, your belongings, everything you and your family own?

Think again.

There is this nasty little doctrine out there called alter ego, and it doesn’t matter that you incorporate in California, this leads to the draconian court action of “piercing the corporate veil.”

What is all of that you ask? Simple. Although you took your business and you went ahead to incorporate in California, that doesn’t mean you automatically get protection from the corporation.

To incorporate in California properly, you must not only form the corporation, but also maintain it and treat it as a separate being. That is where “alter ego” comes into play. If the court feels that the corporation is just an alter ego of yourself, an extension of yourself, then they’ll want to throw it out. It’ll be as if you didn’t incorporate in California but operated as a sole proprietor instead. That leaves all of your assets open to being sued for business debts and obligations!

This alter ego doctrine goes way back, to England in the 1700′s! I know what you’re thinking, I want to incorporate in California what the heck do I care happened in England. But the brief history lesson is necessary so you may have more understanding to avoid the pitfalls. Basically, was the corporation a facade, and did your personal dealings and transactions dominate business activity? Did you incorporate in California but continued to act like you did not?

If so you risk the corporation being deemed an alter ego. Some other colorful names:

They are, mere adjunct, agent, alias, alter ego, alter idem, arm, blind, branch, buffer, cloak, coat, corporate double, cover, creature, curious reminiscence, delusion, department, dry shell, dummy, fiction, form, formality, fraud on the law, instrumentality, mouthpiece, name, nominal identity, phrase, puppet, screen, sham, simulacrum, snare, stooge, subterfuge, tool.

So what does piercing the corporate veil mean? Keeping in mind there are many ways the court may pierce the veil, not just alter ego. However, piercing the corporate veil after you incorporate in California could be devastating. You decide one day, to protect your family’s assets from business dealings, that you are going to incorporate in California. But you treat the corporation as if it were a third arm. You do transactions, dealings, etc. commingling business and personal. That recipe is ripe for  a piercing. Now the court tells you, sorry, you went through all that trouble to incorporate in California, to file the forms, but we’re going to ignore all of that. Your assets are all fair game.

That is definitely a situation you want to avoid at all costs.  It is not something you want to risk.

Incorporate In California – but do it right. Learn all of the requirements and procedures. There are many.

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There are many small business owners who want to incorporate in California, but don’t want to pay for expensive services to have it done for them. There is nothing wrong with that as I am the same way, I try to do everything myself before paying someone else because, one it’s always good to save money, and two,  it’s fun to learn something new. You get that sense of achievement.

However, when I set to do something on my own, I always check out the risks involved of not having a professional do it. So what are the risks of trying to incorporate in California yourself instead of having it done by a professional? Well first we must look at the risk of having your corporation thrown out, disregarded, nullified.

The consequence of that is, of course, losing the protection of the corporation and exposing all of your personal and family’s assets to creditors and claimants. It’s as if you didn’t incorporate in California at all, and just operated the business as a sole proprietorship.

That is the worst case scenario. Less dramatic, are fines, suspensions and extra fees if you fail to properly incorporate in California, and properly operate your corporation. Just one of these mistakes include:

You incorporate in California but fail to treat the corporation as a separate entity

This is a big one. This is where you see courts piercing the corporate veil. You’ve start a business, incorporate in California (by forming an entity). That’s the key word, “entity.” The business is now in a form that is separate and apart from you.

You must treat it as so after you incorporate in California. Before you incorporate in California (as opposed to Nevada where they have different rules) there was no harm in doing so, afterwards though, you have to abide by the formalities. The business cannot be comingled with your personal affairs. You cannot share bank accounts. You cannot share assets, or property. Do not pay your business expenses with personal assets, and do not pay your personal expenses with business assets.

You must treat the business as if it is a completely different entity.

Pretend the business is not owned by you, but owned by someone else completely. It must pay rent, it must have its own bank accounts, it must have its own tax id.

You cannot use business money to purchase personal items. You must transfer it to yourself first, and record it like a normal transaction.

If the courts feel that you used the business as an “alter ego” then it will ignore the “corporate veil” and pierce through it right to your personal assets.

To the court, it is as if you didn’t incorporate in California. At all.

That is why it is wise to seek out all options when you go to form the business. Incorporating on your own may, or may not be, the best idea for you.

Still think you can Incorporate in California by yourself? Well here is a video to help you out.

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What is a buy-sell agreement? This is a question you need to know the answer to, if you incorporate in California with at least one other person. Unless that person is your spouse, I would recommend one in almost any situation.

A buy-sell agreement, or buyout agreement, is a contract between two or more owners of a business that determines what happens when an owner dies, is forced out, or leaves and wants to sell their shares. Sometimes it’s called a business will or a premarital agreement for business. If you incorporate in California you should definitely consider drafting one between the owners.

So why do you need one, if you incorporate in California? After all, you’re a corporation. There is already enough paperwork with that as it is, now you need another agreement, another set of papers? Yes. You can never predict the future. Anything can happen tomorrow, and the buy-sell agreement determines what will happen.

Often times when you take a business and incorporate in California, you will either create a bylaws, a shareholder agreement, or an operating agreement. This can sometimes hold the buy-sell agreement, but often it does not. Some of the provisions such an agreement may determine:

• Who is able to purchase a departing owner’s share of the company
• What specific events will initiate a buyout, (some of the most common events that trigger a buyout are: death, disability, retirement, or an owner leaving the company) and;
• What the purchase price will be for the departing member’s ownership

Incorporate in California – What is an insured buy-sell agreement?

Also if you incorporate in California with a legal profession or financial planing professional, you will often get recommended an insurance policy on the agreement. This means if owner passes away, and there is a purchased insurance policy, then on death the company is paid that large amount paid by the insurance company. This ensures the aggreement is well funded and also that there will be cash available when a buyout is triggered.

Buy-sell agreements can even come into play with divorces. Let’s say you incorporate in California with another owner. But each of you are married. If the company was started with money earned after marriage, your spouses may be entitled to half of your interests in the company. If you then get divorced, that ownership may actually be split up, not something you foresaw when first thinking to incorporate in California. Now, you have your former spouse as a shareholder, perhaps that isn’t something anyone wants. So a good buy-sell agreement has divorce as a trigger to avoid any unwanted shareholders.

Bottom line, incorporate in California with more than one owner, then create a buy-sell agreement.

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The articles of incorporation is the first document filed with the Secretary of State if you wish to incorporate in California. It is what you can call, the master or controlling document of the corporation.

When you incorporate in California, you file articles of incorporation with the Secretary of State’s office, along with the appropriate filing fee. As of 2011 that fee is $100. The documents are then reviewed by the Secretary of State’s office to see if it complies with the applicable law and regulations for your specific type of corporation that is to be formed.

If the documents meet all of the requirements, than the Secretary of State must accept and file the articles of incorporation as of the date they received it, unless a specific future effective date is requested in a cover letter accompanying the document.

Once you officially incorporate in California, your business now can engage in any lawful business activity, subject to limitations specifically put into the articles, or by law. So when you incorporate in California, you have to make a choice of whether to limit the business activities in your articles, or to leave it open ended for flexibility.

There are mandatory provisions that must be in your articles if you incorporate in California:

1. Name
2. Purpose
3. Agent for service of process
4. capital Structure

What else should you consider when you incorporate in California?

There are also optional provisions, and also prohibited provisions as well. So check the appropriate statute and laws to make sure your articles are compliant. The Secretary’s office is backlogged as of this writing and it takes a few weeks or months even so you do not want to make a mistake or else you will be in the back of the line of many business owners trying to incorporate in California, just like you.

Next you have to consider names. To incorporate in California you must have a name that nobody else has. If it is too similar or confusing with another name, it will not be approved. There are also trademark/service mark considerations as well.

Also if you are not going to name directors in the articles, you need to identify all incorporators.  Who are they? The ones doing the work on the business to incorporate in California, that’s who.

Also the number of shares authorized. This is different than issued. Authorized means the company can offer that many shares. Issued means the number of shares actually sold.

So there you have it. When you decide to incorporate in California, the very first step is to file the articles and these are some of the issues and topics you must be aware of.

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