Most new business ventures are formed as corporations. In some instances, a limited liability company (LLC) is more appropriate. Occasionally, a new business venture is begun as a sole proprietorship or a partnership. Knowing what entity to establish is not always intuitive.
A corporation is a separate and distinct legal entity that protects (except in rare cases) its owners (shareholders) from liabilities incurred by the corporation. This means that creditors of the corporation can only enforce their debt against assets of the corporation, and not the individual assets of the shareholders. As a separate legal entity, a corporation files its own tax return, engages in its own business transactions, and acts as the employer for its employees.
A corporation is formed by filing articles of incorporation with the California Secretary of State. A corporation must also have bylaws (its operating rules) and minutes of the organizational meeting of the corporation in which the principal place of business is set, the directors are elected, the officers are appointed, and various other matters are handled. A corporation must also issue shares of stock to its shareholders in return for appropriate consideration. This consideration forms the capitalization of the corporation. Although there is no set dollar amount, this capitalization must be sufficient to fund the initial operations of the corporation. If a corporation is undercapitalized, this is one of the elements that a creditor can look to, to "pierce the corporate veil" and impose corporate liability upon the shareholders. Therefore, it is very important that a corporation be adequately capitalized.
Corporation formation also entails filing notices with the California Department of Corporations, obtaining a Federal Tax I.D. number from the Internal Revenue Service, and a variety of other forms and documentation.
After it is properly formed and capitalized, the shareholders need to hold a meeting once a year to review the corporate financial statement and the actions of the directors during the previous year. The shareholders must also elect directors to serve for the upcoming year. This can be done by a formal meeting or by a unanimous written consent of all of the shareholders without a meeting.
The directors must also have a meeting (or sign a unanimous written consent in lieu thereof) once a year. At this meeting, the directors elect the officers of the corporation, ratify the financial statement and any other major corporate activities (such as leases, capital acquisitions, 401K contributions et cetera) that occurred during the previous calendar or fiscal year.
In a situation where there are two or more shareholders, those shareholders often find it advantageous to execute a buy-sell or cross-purchase agreement so that one of the shareholders cannot sell their stock to a third party who then has the same rights and duties of the selling shareholder. Most shareholders want to have, at least, a right of first refusal to purchase another shareholder's stock before it is sold outside the shareholder group. Many times the shareholders also want to plan to buy out the shares of a deceased shareholder from his or her estate. This buyout is often funded with insurance.
A limited liability company is similar to a corporation, although for taxation purposes, it is taxed as a partnership, and not as a separate legal entity. An LLC has members instead of shareholders, and it has a manager (or managers) instead of directors. An LLC may have officers, but it is not required to do so.
An LLC is formed by filing articles of organization. Its operations are governed by an Operating Agreement, instead of bylaws and minutes.
As a general rule, once an LLC is formed, you do not need to have minutes or unanimous written consents on an annual basis. It generally operates without the formalities of a corporation. An LLC needs to be adequately capitalized in the same fashion as a corporation, and the members and managers must keep the LLC finances separate and apart from their individual finances.
An LLC is taxed as a partnership. However, in California, an LLC also must pay a gross receipts tax. This is a graduated tax (and is in addition to any taxes that are due to the Franchise Tax Board) that has a cap of $11,790. Because many of our clients would prefer to avoid this gross receipts tax, they find a corporation more advantageous than an LLC. However, Jerry is able to form both entities and are comfortable discussing your options with you.