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Business Formation: Protecting Your Business and Your Personal Assets

          When you are thinking of starting a business, you may have questions about protecting yourself and your assets.  You may also have questions as to which type of business entity you should form for your business needs.  So, what is the best entity for your business and what are the benefits and protections of forming each type?  

          Overall, there are four major categories of business entities used in California businesses today; the sole proprietorship, the partnership, the corporation, and the limited liability company (known as an “LLC.”)  Perhaps the most basic of entities is the sole proprietorship.  To create a sole proprietorship, it does not need to be registered with the California Secretary of State like many other businesses entities.  It is essentially formed when you began to operate your business.  Unlike other business entities a sole proprietorship is not considered a separate legal entity from its owner. (Twenty-Nine Palm Enterprises Corp. v. Bardos, (2012) 210 Cal. App. 4th 1435, 1450.)  For example, if you open a used car dealership called “Greg’s Used Autos,” as the owner and operator of that dealership you are operating your business as a sole proprietor and your business entity is categorized as a sole proprietorship.  Although it may be easy to form, as a sole proprietor you are personally responsible for all debts and responsibilities of the business. (Century Surety Co. v. Polisso, (2006) 139 Cal. App. 4th 922, 943.)  Merely using a fictitious business name, such as “Greg’s Used Autos” does not create a separate legal entity that protects you personally from obligations of the business.  (The Rossdale Group, LLC v. Walton, 12 Cal. App. 5th 936, 940.)  What this means for you and your business is that if you face legal troubles or financial responsibilities, your personal assets could be at risk and your assets will not be free from the grasp of those who have claims against you.

          Like a sole proprietorship, a partnership is less formal and does not need to be registered to be recognized.  However, unlike a sole proprietorship, as you may have guessed, a partnership involves “two or more persons to carry on as coowners a business for profit formed under Section 16202.” (Cal. Corp. Code § 16101.)  As a partner in a partnership, you do not have to intend to create a partnership. (Cal. Corp. Code § 16202(a).)  So long as the partners are sharing in the profits of the business, a partnership is formed (subject to some exceptions per Cal. Corp. Code § 16202(c)(3)). (Cal. Corp. Code § 16202(c)(3).)  Like a sole proprietorship, partners in a partnership are personally liable for obligations of the partnership unless the partners come to an agreement otherwise or as permitted by law. (Cal. Corp. Code § 16306(a).)

          In order to avoid personal liability and protect your assets, you might consider forming a corporation or a LLC for your business.  Unlike a sole proprietorship or partnership, a corporation and a LLC are separate legal entities that exist apart from the directors or managers who operate the entities. (Twenty-Nine Palms Enterprises Corp., 210 Cal. App. at 1452; Curci Investments, LLC v. Baldwin, (2017) 14 Cal. App. 5th 214, 221.)  This means in the eyes of the law, your business and yourself are separate entities.  Going back to our dealership example, yourself and your business, “Greg’s Used Autos” would be separate entities under the law.  So, unlike a sole proprietorship or partnership, if “Greg’s Used Autos” is sued or has debts, only the business’ assets can be reached by the claimant and not your own.  However, there are exceptions where the “corporate veil” or “LLC veil,” that is the veil of protection for your personal assets, can be pierced and therefore your personal assets reached, but, that is a topic for another article. 

          Also unique to the corporation, is the way in which it is taxed.  There are two major types of corporations, the S-Corp and the C-Corp.  The C-Corp is subject to “double taxation.”  That means the corporation’s income is taxed and then the owners, not the corporation, pay taxes on the dividends paid from corporate profits.  A S-Corp, like a LLC, a sole proprietorship, and a partnership, have what is called “pass-through taxation,” where the business income is not forced against the business, instead you report and pay personal taxes on income that your business produces.

          A corporation is formed by selecting a name with the California Secretary of State, preparing and filing an Articles of Incorporation, appointing a registered agent for service of process, determining the types of stocks and shareholders, preparing corporate bylaws, appointing directors to serve on the board, issuing stock, filing a Statement of Information, (the SI-200 form located here: https://www.dir.ca.gov/dlse/regulation_detail/SI-200.pdf), and paying an incorporation fee.  The Articles of Incorporation contain information pertaining to the name of the corporation, the registered agent, the initial board of directors, the number and type of shares, and the name and signature of the incorporator. (Cal. Corp. Code § 200.)  The bylaws are rules that govern how a corporation conducts its business. (Cal. Corp. Code § 212.)  A corporation, unlike a sole proprietorship or partnership, is a separate entity, and depending on which type you form either has pass-through or double taxation.

          A very popular business entity today is the LLC, which stands for a limited liability company.  LLCs have become a more popular option over the corporation as it is more user-friendly for the small-business owner.  Like a corporation, an LLC can be formed by finding an available name with the California Secretary of State, filing the appropriate paperwork called the Articles of Organization (the LLC-1 form located here: http://bpd.cdn.sos.ca.gov/llc/forms/llc-1.pdf), drafting and submitting an Operating Agreement, and paying a fee. (Cal. Corp. Code § 17701.01, et al.)  The Operating Agreement, like the corporation’s bylaws, governs the relations among the members and the LLC, the rights and duties of the managers, the activities of the LLC, and the means to amend the Operating Agreement. (Cal. Corp. Code § 17701.10(a)(1)-(4).)  If you form a LLC, your business is a separate entity, and is subject to California tax, in which you must report its income on your tax return and pay taxes on this income.

          No matter which entity you believe is best for your needs, the attorneys and staff at Madison Law, APC, are qualified and skilled in aiding in the formation of your business entity and serving as your agent for process.  In the event your entity facies legal troubles or obligations, Madison Law, APC’s, attorneys are leaders in litigating the suits you wish to bring or may face during the course of your business.

Rebecca J. Chmura

bchmura@madisonlawapc.com

 

 

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