As you ramp up your business, there are most likely a million things you, as an entrepreneur, are trying to do at once. One of the key decisions you must make is deciding which legal entity, corporation, or partnership is the right choice. This can make a huge difference when it comes to protecting your assets, taxes, and your financials. Our Santa Clara County business law attorney at Napolitano Law Office can provide the advice and assistance you need to make the right choice.
Prudent planning early on can eliminate the need to restructure later, which can be an expensive and timely process. Below is a roundup of available business entities in California, highlighting certain key features to understand the range of options. We encourage you to contact our office to discuss the business entity that is right for your start-up.
For example, if you sell lemonade as a sole proprietor and someone gets sick from drinking it or if someone sues you for breaching your contract to fulfill a bulk lemonade order, you would be personally liable for the full amount of the judgment—meaning your personal assets are on the line. If you agreed to share profits and control of the lemonade business with a friend—i.e., a general partnership—the partners would be jointly and severally liable for partnership debts, meaning each person is liable for the full amount of the partnership debts until they are fully paid off.
An LLC is a highly customizable entity through which a company could set up structures similar to a C-Corp. An LLC can have shareholders—called “members”—and different classes of stock with customizable rights, and can even elect to be taxed just as a C-Corp. An LLC is generally easier to setup and easier to maintain because fewer formalities are required.
State filing required and subject to the state franchise tax—minimum $800 per year
Other key requirements include adequate capitalization, record keeping, holding annual meetings, and keeping personal and corporate assets separate.
Certain types of liabilities belong only to the company
Taxed as an entity, and shareholders are also taxed when they receive any dividends or distributions. If, for instance, the company becomes insolvent and cannot pay its creditors, the liability will belong solely to the company. Other contractual liabilities and obligations also belong solely to the company. Employment obligations such as unpaid wages are the company’s obligation as well.
Founders will typically not be responsible for these matters unless the corporate veil is pierced, which requires a finding that the company was being used for fraudulent purposes or neglected to follow corporate formalities such as paying taxes or holding meetings. Although this “double taxation” can seem unattractive to business owners, strategic tax planning can render this tax treatment beneficial.
C-Corporation investments receive special, advantageous tax treatment if the investment is “qualified small business stock” (QSBS). There are specific parameters for eligibility for this treatment, but in essence, under Section 1202 of the Internal Revenue Code, an individual taxpayer can exclude 50% or more of the gain realized on the sale of a QSBS stock if the taxpayer holds the stock for more than five years prior to sale. The taxpayer can also defer recognition of gains if the taxpayer reinvests in QSBS within specified time parameters. This nice perk for investors only applies to investment in C-Corps, not LLCs.
A S-Corp provides decent protection for its shareholders from personal liability regarding the company, since the S-Corp is considered to be a separate entity from the owners and investors. In order to form an S-Corp in California, you must first incorporate in the state and then request consideration as an S-Corp. If you are willing to put forth the extra effort for formation and management, a S -Corp has added benefits such as possibly avoiding a self-employed tax and surviving as a separate entity after a shareholder leaves.
One way that companies protect employees, directors, and officers is through indemnification provisions in their company by-laws. Another way the company may protect the officers and directors is through directors and officers insurance, or “D&O Insurance.”
Apart from this, founders may take care to ensure that:
No matter what type of business you wish to start, it is always wise to consult with a Santa Clara County business law attorney who is familiar with the state and federal business laws that apply to you. Our team at Napolitano Law Office is here to help you. We can help ensure that you are in full compliance with the law and that you choose the business entity that will most help your company thrive.
Self-help has its place in small companies, but it almost invariably falls short when it comes to the complex setup issues associated with a startup. In this area, get a good startup business lawyer and do it right. We at Napolitano Law Office are happy to set up a free overview phone consult for businesses. Whether you need one-time business consulting or ongoing guidance during your business journey, we are here to help.
Call us today at (650) 399-9545 to make a phone appointment.