When forming a business in California, the first step is deciding what type of entity is best (for example, a corporation, partnership, or limited liability company (LLC)). The best entity form depends on the entity’s intended purpose, structure, liability, tax, and management considerations.
LLCs offer substantial flexibility and combine the liability protection of a corporation with the option of tax treatment as a partnership (single member LLCs that are considered disregarded entities are the exception) For these reasons, LLCs are increasingly popular business entities.
Advantages of an LLC include:
- Limited liability of the members.
- Greater flexibility in allocating profits among members.
- Freedom to contract for the management of the LLC’s business, often superseding default statutory requirements.
- Fewer formalities than a corporation. For example, an LLC is not required:
- to have annual meetings; or
- to keep written minutes of its proceedings.
- Pass-through taxation to avoid double taxation, unless the members choose an alternative tax classification (see Practice Note, Choice of Entity: Tax Issues).
- Fewer restrictions on ownership.
Disadvantages of an LLC include:
- Additional hurdles if the LLC plans to eventually become a public company.
- Generally, more complex than a partnership.
- Less common law precedent than a corporation since LLCs are relatively new entities in comparison.
There following issues are worth considering when forming an LLC.
- State of Formation
Before forming an LLC, the organizers must determine the LLC’s state of formation. LLCs are governed by the laws of the state of formation. In California, the California Revised Uniform Limited Liability Company Act (RULLCA) (Cal. Corp. Code §§ 17701.01 et seq.) governs the management and operation of an LLC and includes provisions concerning issues such as:
- Management by members or managers.
- Contributions and distributions.
- Membership, assignment of member’s interests, and dissociation.
- Mergers and conversions.
Organizers may also want to consider where the LLC will primarily transact business and if there are any business, tax, social, or policy reasons for choosing a particular state. Forming in the state where the LLC will primarily conduct business is typically the easiest and most cost effective. If the LLC organizes in a different state, it must qualify to conduct business in the state where it primarily transacts business, which requires additional filings and fees, essentially a duplication of costs and filings.
- Name of the LLC
Requirements and Restrictions
The name of a California LLC must:
- Contain the term “limited liability company” or the abbreviation “LLC” or “L.L.C.” “Limited” may be abbreviated to “Ltd.” and “company” to “Co.,” but these abbreviations are not preferred.
- Not include the terms:
- insurer; or
- insurance company.
- Not be likely to mislead the public, as determined by the California Secretary of State (SOS).
- Be distinguishable in the SOS’s records from the name of any California LLC or foreign LLC authorized to transact business in California and any name reserved under RULLCA.
(Cal. Corp. Code, § 17701.08.)
Parties can informally check the availability of a business name in California by performing a search on the SOS website. Parties can formally check the availability of a business name in California through the SOS. Checking availability does not reserve the name.
Final name approval is determined by the SOS, so a name should not be used until the SOS acknowledges that the articles of organization were accepted for filing. Organizers should have backup name choices in case a name is already taken or rejected, particularly if an attorney is handling the filing for a client.
Intellectual Property Searches
If the LLC intends to use its name as a trademark, service mark, domain name, or trade name, consider running a trademark search to see if the name is registered by another business. Federal trademark searches can be conducted for free online with the United States Patent and Trademark Office. Trademarks and service marks can also be registered at the state level. More than just the words are required for a trademark, so it is wise to think through font, colors and design you want to use.
After deciding on a name, parties can reserve it for 60 days by filing a name reservation request. After the name reservation has expired for at least one day, parties can renew the reservation for another 60-day period. Often in our practice my firm will cause the entire filing to be completed within days of choosing a name making the name reservation process less necessary.
The name reservation request can be filed online, with the accompanying $10 filing fee (see Practice Note, Filing Documents with the Secretary of State (CA) and SOS.
Fictitious Business Name
If the LLC will use a name other than the one listed in its articles of organization, it must file a fictitious business name (FBN) statement with the clerk of either:
- The county where the LLC’s principal place of business in California is located (see, for example, Los Angeles County Register-Recorder/County Clerk: Fictitious Business Names).
- Sacramento County, if the LLC has no place of business in California
(Cal. Bus. & Prof. Code § 17915.). An LLC may file an FBN statement in other counties so long as the requirements of Section 17915 are also met (Cal. Bus. & Prof. Code § 17915).
After filing the FBN statement, the LLC must:
- Within 30 days, publish the FBN statement in a newspaper of general circulation in:
- the county where the FBN statement was filed;
- an adjoining county (if the county of filing has no newspaper of general circulation); or
- Sacramento County, if the LLC has no place of business in California.
- Within 30 days after completion of publication, file an affidavit of publication with the clerk of the county where the FBN statement was filed.
(Cal. Bus. & Prof. Code § 17917(a), (d).)
One should be mindful of whether they wish to create a trademark when considering to do business in the name of the LLC or instead use a FBN.
- Pre-Formation Logistics
Once California has been identified as the state of formation and the LLC’s name has been chosen, determine:
- Who the organizers will be. In California, one or more organizers prepare, execute, and deliver to the SOS the articles of organization. An organizer is not required to be a member of the LLC. (Cal. Corp. Code § 17702.01(a).) An attorney often acts as the organizer, but an organizer does not need to be an attorney.
- Whether to use a service company to file the formation documents. Although many law firms and companies pay a service company to file documents, it is not legally required. Before using a service company, inquire about the fees they charge for handling the filing.
- Whether the filing needs to be expedited. California offers expedited filing for a fee.
- The LLC’s designated office in California. California LLCs must designate and maintain an office (which need not be a place of business) in California (Cal. Corp. Code § 17701.13(a)(1)).
- The LLC’s agent for service of process. California LLCs must designate and maintain an agent for service of process in California, which may be:
- a natural person who resides in California; or
- a domestic or foreign corporation that has filed the required certificate with the SOS and otherwise complied with Section 1505 of the California Corporations Code, including being authorized to do business and being in good standing in California (Cal. Corp. Code § 1505).
- Whether the LLC will have a perpetual duration or a specific date of dissolution. Under RULLCA, an LLC has perpetual duration, subject to certain dissolution events set out in the articles of organization or a written operating agreement (Cal. Corp. Code §§ 17701.04(c) and 17707.01(a)).
- Whether the LLC will be a single member or multi-member LLC. An LLC may have one or more members (Cal. Corp. Code § 17704.01). A member is an individual or legal entity (domestic or foreign) that has become a member of an LLC and has not dissociated as a member (Cal. Corp. Code §§ 17701.02(p), (v), 17704.01, and 17706.02). If two or more parties are forming the LLC.
- Whether the LLC will be member-managed or manager-managed. An LLC is member-managed unless the articles of organization contain a statement that the LLC is manager-managed (Cal. Corp. Code §§ 17702.01(b)(5) and 17704.07(a)). A manager is an individual or a legal entity (domestic or foreign) responsible, under the operating agreement, for performing the LLC’s management functions (Cal. Corp. Code §§ 17701.02(n), (v) and 17704.07(c)).
- The type of operating agreement. An operating agreement may be a short-form or long-form agreement. Members may enter into one comprehensive long-form operating agreement or a series of one or more stand-alone agreements covering different matters (Cal. Corp. Code § 17701.02(s) and see Operating Agreement).
Existing Business Converting to an LLC
There may be situations where an existing business wants to become an LLC. A foreign or domestic business entity, including a corporation, limited partnership, or general partnership, may generally convert to a California LLC if the entity is permitted to convert by the laws under which it is organized (Cal. Corp. Code § 17710.08(a)). This conversion, perhaps from a partnership or sole proprietorship to an LLC, follows many of the aforementioned considerations with the additional considerations of potential tax consequences of the conversion and how to value the transferred assets for capitalization considerations.
There may be tax consequences associated with converting to an LLC. The converting entity should consult a tax professional before taking any action.