What is a California LLC?
Before covering how to form a California LLC, it is important to know what a California LLC is, if it is the optimal entity for your business, and whether or not your business is permitted to operate as a California LLC.
LLC stands for “limited liability company”. An LLC is type of business entity that has a high degree of flexibility and permits pass through taxation. For liability purposes, the LLC is treated like a corporation in the sense that the LLC members are not generally liable for the debts and obligations of the LLC. In 1994, the passage of then Beverly-Killea Limited Liability Company Act made it possible to form a California LLC. Since then, the LLC entity has become an increasingly popular entity choice among business owners.
The owners of the LLC are called members. The members are the LLC equivalent of corporate shareholders. Rather than shares, these members have membership interests. The members enter into an Operating Agreement which governs the LLC and the member’s rights and responsibilities. The Operating Agreement is the LLC equivalent of corporate bylaws. An LLC Operating Agreement can generally be viewed as allowing a high degree of flexibility in structuring member financial interests in comparison to an S Corporation.
Which entity is better, an LLC or a Corporation?
The choice is one of circumstance. Both the LLC and the corporate structure have benefits and drawbacks. One primary benefit to using the LLC over the corporate structure for a new business is that it usually involves less corporate formalities than the corporate structure. If an owner runs afoul of such formalities, by commingling personal and corporate assets, or failing to observe the basics, such as timely issuing shares, or failing to maintain adequate corporate records, they risk losing their limited liability protection. In addition to the corporate formalities issue, there are many other factors that should be considered when deciding whether an LLC or a Corporation makes the most sense for you, and it is also recommended that you consult with an attorney before making the decision. For more information, please view the article S corporation versus LLC.
If you are not ready to form a California LLC, another option your have is to not use an entity at all, and operate your business as a sole proprietorship. A primary advantage of the sole proprietorship is that they are simple to form in that they are automatically created, and there are no legal or state fees, aside from possibly filing a DBA. The primary disadvantage to running your business as a sole proprietorship is that you will not be afforded the limited liability protection of an entity, and you will be subject to personal liability for the liabilities of your business.
Am I Ready to Form a California LLC?
If you elect to run your business as a sole proprietorship and also want to call our business something memorable you might consider a DBA (D/B/A).
For example, if your name is “John Doe” and you want to call your business “Carpet Cleaner King”, but you will not be creating an entity called “Carpet Cleaner King, Inc.” or “Carpet Cleaner King, LLC”, it is fairly straight forward to obtain a “DBA” (which stands for “doing business as”), which allows you to operate as a sole proprietorship, in other words “John Doe d/b/a Carpet Cleaner King”.
If you have limited personal resources to protect, and are starting a small service oriented business where liability is unlikely to be high, this can be an acceptable method of operation. However, as you begin to acquire personal assets, have more clients, hire employees, engage partners, or begin thinking about an exit strategy for your business, you will want to strongly consider a separate legal entity for your business, such as an s-corporation, a c-corporation, or a limited liability company. When obtaining a DBA, you should always ensure the name you are using is not already in use by another company.
Is My Business Eligible to Form a California LLC?
One threshold question to ask before forming a California LLC is if your business can operate in the LLC form. In California, some professionals, like attorneys for example, are prohibited from organizing their business as a California LLC and must instead consider alternatives forms, such as a limited liability partnership. This threshold question should always be investigated before forming a California LLC.
How to Form a California LLC
1. Choose an LLC Name
Ensure that your selected LLC name is available by conducting a Preliminary Name Search and Clearance with the California Secretary of State to ensure the LLC name you have selected is available. In some instances, we also recommend a second name search at the federal level to ensure that the chosen LLC name does not infringe upon an existing trademark registration.
General LLC Naming Guidelines: As a general guideline, an LLC name must contain (as the last words of the name) the words “limited liability company” or the abbreviation “LLC” or “L.L.C.” It is permissible for the words “limited” and “company” to be abbreviated to “Ltd.” and “Co.”. In addition, the name must not contain the words “bank,” “trust,” “trustee,” “incorporated,” “inc.,” corporation,” or “corp.,” or “insurer” or “insurance company” or words suggesting that the LLC is in the business of issuing policies of insurance and assuming insurance risks.
2. Articles of Organization
In the formation of a California LLC, a document called the “Articles of Organization” must be filed with the Secretary of State. California law requires that certain information must be included in the articles.
The Articles of organization are the LLC equivalent of corporate articles of incorporation. The articles of organization must contain the name and address of the LLC as well as the agent for service of process and their address. The articles of organization must also state whether or not the LLC is member managed or manager managed. Finally, the LLC must be signed by the organizer of the LLC (this does not need to be a member of the LLC)
3. Articles of Organization Cover Letter
A cover letter to accompany the Articles of Organization to be filed with the California Secretary of State must be prepared.
4. EIN Number and Form SS-4
In order to open a bank account in the name of your new California LLC, at a minimum, a bank will often require you to provide a copy of the stamped Articles of Organization together with an EIN number. An EIN number is a Employer Identification Number and allows the IRS to identify and tax administer your entity. In order for an attorney or third party to file for your EIN, a IRS Form SS-4 must be completed. Once the SS-4 is on file, it is fairly trivial to obtain an EIN number from the IRS electronically.
5. LLC Operating Agreement
Preparation of a Limited Liability Company Operating Agreement for a single member LLC. The work involved in preparing an LLC Operating Agreement can vary considerably based on the unique factual and economic circumstances. For example, an operating agreement that would be suitable for a single member LLC would not typically be suitable for a multi-member operating agreement. Similarly, a simple multi-member operating agreement that called for a pro-rata allocation of profits and losses would not be appropriate in a situation where the members desire a preferred return on capital, a waterfall arrangement, or other non pro-rata allocations for tax purposes.
An LLC Operating Agreement should always be carefully considered by the members. This Agreement is not filed with the California Secretary of State. However, the Operating Agreement is of critical importance because it outlines all the member rights and their responsibilities. It is always advised that parties get an attorney to draft and explain the Operating Agreement rather than sign a boilerplate agreement that does not fit their situation.
6. Organizational Minutes and corresponding Organizational Certificate of Organizer
These documents further memorialize the organization of the LLC.
7. Membership Interest Issuance Letters
The investment representation letter for each member of the LLC requesting their membership interest is commonly issued pursuant to Corporations Code Section 25102(f), but there are a number of other applicable exemptions that sometimes apply.
In addition, a completed Notice to the Commissioner of Corporations regarding the issuance must be filed. Typically, these days, this type of notice is filed online.
8. Statement of Information
The Statement of Information is a simple form that lists some biographical information about the LLC including the company’s managers, agent for service of process and general type of business. In addition to the initial statement, a Statement of Information must be filed bi-annually, and failure to file or late filings will subject the LLC to penalties.
9. Tax Election Forms
If desired, the LLC may elect to be taxed as a corporation, this is not typical and an attorney and accountant should usually be consulted.
10. Spousal Consent
Preparation of a Spousal Consent Form (if required): Because California is a community property state, if, during marriage, one spouse acquires an interest in a business, the other spouse by operation of the California community property laws will have a community-property interest in that business.
Because LLC Operating Agreements or a corresponding LLC Buy-Sell Agreement will often have restrictions on transfers that could be abrogated by an event such as death or divorce of a spouse, it is prudent to have a spouse (or domestic partner) agree to such provisions through a spousal consent. A signed spousal consent helps to maximize the likelihood that any restrictions against transferability to a spouse will be enforceable.
11. Preparation of an LLC Record Book
Once the balance of the LLC documents have been prepared, they should be organized and placed in an LLC Record Book, which will typically contain the following documents: (1) any attorney explanation letters on the operation of a California LLC, (2) the Articles of Organization and any amendments; (3) the LLC’s Operating Agreement, and any amendments, (4) the organizational minutes, together with any regular minutes, together with any written consents of the LLC, (5) copies of documents filed with the IRS or state agencies such as a completed SS-4 form, Statement of Information, Commissioner’s Notice, etc.; (6) a list of the names and addresses of the member of the LLC and that member’s contribution and the share in profits and losses; (7) membership interest issuance letters; and (8) any other relevant business records pertaining to the LLC.
Other Important Documents Related to Forming a California LLC
Management and Control Documents
To the extent the LLC is a multi-member LLC, there may be another agreement indicated titled a LLC Buy-Sell Agreement (sometimes also referred to as a Shareholder Agreement). An LLC Buy-Sell Agreement will restrict transferability of membership interests.