How to Select the Correct Entity for your California Business (California Corporations and LLCs)

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SOWARDS LAW FIRM, APC

a California based law corporation

2542 S. Bascom Ave., Suite 200, Campbell, CA 95008

Phone: (408) 371-6000 | Fax: (408) 371-6005

www.sowardslawfirm.com

CHOICE OF BUSINESS ENTITY

I. INTRODUCTION

This outline provides a general overview of the major factors to consider whenorganizing a business and other differences between various forms of business organization. The outline focuses on six principal business forms: the sole proprietorship (SP), the general partnership (GP), the limited partnership (LP), the limited liability partnership (LLP), the limitedliability company (LLC), and the corporation (C).

II. FORMS OF BUSINESS ORGANIZATION

A.Sole Proprietorship. A single individual owns and manages the business. He or she may hire employees, but no one else participates in the profits. The individual pis fully liable for the debts and obligations of the business. The organization and operations of a sole proprietorship is generally governed by common law principles.

B.General Partnership. A partnership exists when two or more persons combinetheir property, services, and/or capital in furtherance of a business venture. Each partner owns an interest in the business and shares in the profits and losses, and is fully liable for the debts andobligations of the business. These are disfavored by most CA attorneys.

C.Limited Partnership. A LP is similar to a GP, except that it consists of at least one general partner and one or more limited partners. A limited partner's liability for the debts and obligations of the partnership is generally limited to the partner's investment in the partnership.

D.Limited Liability Partnership. An LLP is a GP that has registered as an LLP with a state agency. The liability of partners of an LLP for the debts and obligations of the partnership is generally limited to their investment in the partnership, except that a partner remains responsible for his or her own tortious conduct and in some jurisdictions for negligent supervision of others who engage in tortious conduct.

E.Limited Liability Company. An LLC combines certain of the characteristics ofa partnership and a corporation. It is owned by its members, and may be managed by them or by one or more managers who may or may not be members and may be operated either by its members, or managers, or by officers and employees. Members normally are not liable for the debts and obligations of the business.

F.Corporation. A C is a business owned by its shareholders, managed by its board of directors, and operated by its officers and employees. Shareholders normally are not liable for the debts and obligations of the business. The organization and operation of a corporation are normally governed by a corporation statute in the jurisdiction where the corporation is organized.

III. FACTORS

A. Formation.

1. Sole Proprietorship.

(a) Procedures. No formal procedures must be followed or consents obtained in order to form a SP.

2. General Partnership.

(a) These are disfavored by most California attorneys.

3. Limited Partnership.

(a) Procedures. For a partnership to be considered a LP, it must comply with certain statutory requirements. Generally, there must be a written agreement, and a certificate must be filed with the appropriate authority. LP interests are typically considered securities, which must be qualified or registered under applicable state and federal securities laws unless an exemption is available. In most instances, a GP interest is not considered a security.

4. Limited Liability Partnership.

(a) Procedures. In order for a partnership to be considered an LLP, itmust comply with certain statutory requirements. A certificate of formation must be filed withthe appropriate authority. Although some states may not require a written agreement, it isgenerally advisable to have a partnership agreement establishing the manner in which the LLP isto be operated. LLP interests, like GP interests, will generally not be considered securities.

5. Limited Liability Company.

(a) Procedures. As is the case with an LP and an LLP, an LLC must comply with state statutory requirements (e.g., filing articles of organization in California or a certificate of formation in Delaware, and paying filing fees and taxes) before its existence will berecognized. The LLC will also usually have an operating agreement setting forth how the LLCis to be operated. LLC membership interests may be considered securities which must be qualified or registered under applicable state and Federal securities laws unless an exemption isavailable. Formalities, such as minutes of members' and managers' meetings, are not required,but it may be desirable to maintain such records.

6. Corporation.

(a) Procedures. As is true with a LP, a C must comply with state statutory requirements (e.g., filing articles of incorporation and information statements, payingincorporation fees, prepaying taxes, etc.) before its existence will be recognized. To raisecapital, shares of stock are issued in compliance with the relevant securities laws. Extensiverecords must be kept and be available for review by the shareholders. Corporate formalities mustbe met (e.g., bylaws, directors' and shareholders' meetings).

B. Management and Control.

  1. Sole Proprietorship. Owner has complete control of the business unless hehas surrendered some control, for example, to creditors.

  2. General Partnership. In general, each partner can participate in themanagement of the business and can enter into an agreement that will be enforceable against or by the partnership. The partnership agreement, however, will control the GPs actual management structure; many GPs find it helpful to centralize control in one or more managing partners. These are disfavored by most California attorneys.

  3. Limited Partnership. A LP is managed by its general partner(s). If limited partners participate in management, they risk losing their limited liability status. However, most state statutes allow a limited partner to vote on important partnership issues (e.g., termination of the partnership, removal of the general partner, sale of all partnership assets, amendment of the partnership agreement) without losing their limited liability status. In some instances, the limited partner can contract to provide services to the partnership.

  4. Limited Liability Partnership. An LLP is managed by its partners, subject to agreement among them. Unlike an LP, all of the partners of an LLP may participate in management without losing their limited liability status.

  5. Limited Liability Company. An LLC may be managed by its members or by one or more managers who may or may not be members. Management may be through a board of managers that operate in a manner similar to the board of directors of a C, with officers reporting to the managers. The right of members to vote on matters affecting the LLC is usuallygoverned by the agreement of the members, as reflected in its organization documents (e.g., articles of organization and/or operating agreement) but may to some limited extent be specified in the statutes of the state under which the LLC is organized.

  6. Corporation. A C has a standard, hierarchical control structure. It is managed by or under the direction of a board of directors and its officers, although shareholders vote on important corporate issues (e.g., election of directors, mergers, sale of all corporate assets, dissolution). A closely held corporation, by agreement among its shareholders, may adopt management characteristics substantially similar to those of a general or limited partnership.

C. Personal Liability.

  1. Sole Proprietorship. The sole proprietor is personally liable for allbusiness debts. Although the proprietor's assets can be reached by creditors, he or she can insure against some liabilities, such as tort and product based liability.

  2. General Partnership. Each partner is personally liable to outside creditors for acts committed by and obligations incurred on behalf of the partnership, except that newly admitted partners are liable for previous GP liabilities only to the extent of their capital contribution, unless they otherwise agree. Some protection from creditors can be achieved if the general partners are corporations, provided the corporations have sufficient net worth. Insurance may be available. Because of the risk of liability, these are highly disfavored by most California attorneys.

  3. Limited Partnership. Limited partners are liable for the partnership's debts only to the extent of their individual capital contributions. General partners are liable for partnership debts to the same extent as general partners who participate in general partnerships.

  4. Limited Liability Partnership. Partners are liable for the partnership's debts only to the extent of their individual capital contributions, except to the extent that they agree to assume greater liability. Partners are also liable for their own tortious conduct and (in some jurisdictions) for negligent supervision of others who act for the LLP.

  5. Limited Liability Company. Members are normally not liable for the debts and obligations of the LLC, but, as in the case of shareholders in a C, may in some jurisdictions be liable for the debts of the LLC if it is undercapitalized, and are liable for their own tortious conduct on behalf of the LLC.

  6. Corporation. To the extent corporate formalities are met and the corporation is not undercapitalized, shareholders' liability is limited to their investment. However, creditors may require that principal shareholders guarantee corporate indebtedness, particularly debts of small or closely-held companies. Furthermore, shareholders may be liable for their own tortious conduct on behalf of the corporation.

Additional Resources

www.sowardslawfirm.com Sowards Law Firm http://www.sos.ca.gov/ California Secretary of State

California Secretary of State

Sowards Law Firm

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