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Forming a Limited Liability Company

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Forming a California LLC

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This blog post will discuss the steps you'll need to take to form a limited liability company. A later blog post will include post-formation issues that will need to be addressed before your company can begin operating.

Key Takeaways

  • State of formation depends on the location of business activities as well as any business, tax, social, and policy concerns

  • Putting the LLC name on paper is not enough

  • Pre-formation concerns include membership structure and management

  • Articles of Organization and Statement of Information are necessary

  • Although not required, an Operating Agreement is recommended

If you're thinking about forming a business that will operate in California, you'll first have to determine what type of entity you should choose. Choosing the appropriate entity form (for example, a corporation, partnership, or limited liability company (LLC)) is vitally important to the success of your business. Each entity form has different structure, liability, tax, and management considerations.

ONLINE FORMATION FALLS SHORT

Yes, there are plenty of online services that will allow you to cheaply form a business, and use generic, short-form documents to do so. But, using one of these companies for something as important as your personal business is short-sighted and ignores the inherent value of expert advice. If you're looking to cut costs, then you may like to hear you can technically do this all yourself. You just have to choose the correct forms and pay state filing fees. In fact, you can use this blog post as a step-by-step guide to forming an LLC.

But if you're looking for guidance, know that online formation companies cannot navigate the complex nature of individual circumstances. This doesn't fit their business model (an assembly line comes to mind). What's most important is that you understand there is no shortcut to determining which legal entity is appropriate for your business. This requires highly personalized advice regarding the organizational structure, liability, tax, and management considerations. Online companies cannot offer this to you. They're not attorneys.

Rather than delve into the appropriateness of which entity you should choose for your business (which we can offer you since we're attorneys!), we're going to focus on the limited liability company.

 
““...there is no shortcut to determining which legal entity is appropriate for your business.””
— The Schlau|Rogers Team

In general, LLCs offer substantial flexibility to organizers, but also combine the liability protection of a corporation with the tax treatment of a partnership. For these reasons, LLCs are increasingly popular business entities. Some of the advantages of an LLC include:

  • Limited liability of the members. 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.

  • 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 keep written minutes of its proceedings).

  • Pass-through taxation which avoids double taxation (taxation at the entity and personal level), unless the members choose an alternative tax classification.

  • Fewer restrictions on ownership.

While there are numerous advantages to forming an LLC, there are some disadvantages. Disadvantages of an LLC include:

  • Some roadblocks if the LLC eventually becomes a public company.

  • LLCs are generally more complex than a partnership.

STATE OF FORMATION

Before forming an LLC, it's necessary to determine which state of formation is preferable. Where the LLC will primarily transact its business and whether there are any business, tax, social, or policy reasons for choosing a particular state generally determine the state of formation.

Forming an LLC in the state where the LLC will primarily conduct business is typically the easiest and most cost effective option, particularly if it is the your home state. Forming an LLC outside of your home state presents additional issues. For example, a business operating in California will have to register with the California Secretary of State (SOS), pay fees, and take other necessary steps before conducting business in California. If that business is formed in another state (say Nevada or Delaware), it will have to take similar steps in that state, essentially doubling the fees.

That said, there may be some business, tax and legal advantages when forming an LLC in other states such as Delaware or Nevada. For example, an owner of multiple parcels of real property that are located outside of their home state, and are used to generate income may be a good fit for formation outside of California. This is simply because best practice is to separate each property into it’s own “protective shell” and California would require formation of multiple separate entities to do so, thereby increasing administrative fees and costs. States like Nevada, Delaware and others, however, allow for the formation of the Series LLC. A Series LLC prevents the increased administrative burden, but serves to separate each series of the Series LLC into its own cell. Each cell is protected and treated as if it’s own separate entity, but in fact exists only as a series amongst other series in a Series LLC. That Series LLC operates as one separate entity for administrative purposes.

Then again, if the LLC is going to conduct a regulated business in a state other than California, it may be easier to obtain the necessary state licenses if it is a domestic LLC within that state. As you can see, this is a complicated analysis. For more, get in touch.

NAME OF THE LLC

Before drafting formation documents or making any filings, you should determine the name of the LLC. The name of an LLC must:

  • Contain the words “limited liability company” or the abbreviation “LLC” or “L.L.C.” The words “limited” and “company” may be abbreviated to “Ltd.” and “Co.” but these abbreviations are not preferred in practice.

  • Not include the terms “bank,” “trust,” “trustee,” “incorporated,” “inc.,” “corporation,” “corp.,” “insurer,” or “insurance company.”

  • Not be likely to mislead the public, as determined by the SOS.

  • Be distinguishable in the SOS’s records from the name of any domestic or foreign LLC authorized to transact business in California and any name reserved under California Revised Uniform Limited Liability Company Act (RULLCA), unless:

    • the LLC delivers to the SOS a certified copy of the final court judgment establishing the LLC’s right to use the name in California; or

    • the holder of the existing name consents to the new LLC’s use of the name and submits an undertaking to the SOS to change its name.

You also need to check the availability of a business name in California by performing a search on the SOS website. Performing this informal test is not determinative of availability and does not reserve the name you’ve chosen. Final name approval is determined by the SOS, so you shouldn't use a name until the SOS acknowledges that the Articles of Organization were accepted for filing. You can also request that your attorney perform a formal name availability request with the SOS to ensure availability. 

If the LLC intends to use its name as a trademark, service mark, domain name, or trade name, you’ll also need to perform a trademark search to see if the name is currently 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. You should have backup name choices in case a name is already taken or rejected.

Name Reservation

After deciding on a name, your attorney can reserve it by filing a name reservation request, available on the SOS website (see Secretary of State: Name Reservation Request). This reservation only lasts for up to 60 days and will expire after that. Additional time can be requested after expiration of at least one day.

Fictitious Business Name

There is often confusion as to whether a business will require a 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:

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 publishing, file an affidavit of publication with the clerk of the county where the FBN statement was filed.

PRE-FORMATION CONCERNS

Once the state of formation and the name of the LLC have been identified, you need to determine:

  • Who the organizers will be. These are the people who prepare, execute, and file the Articles of Organization. An attorney often acts as the organizer, but the organizer does not need to be an attorney. An organizer is also not required to be a member of the LLC (Cal. Corp Code § 17702.01(a)).

  • Whether the filing needs to be rushed. California offers expedited filing for a fee. Although there is an extra charge, it is sometimes necessary if the formation is time-sensitive, such as if the LLC is being formed in connection with an acquisition.

  • The LLC’s designated office in California. California LLCs must designate and maintain an office (this does not need to 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. In California, an agent for services of process is either:

  • Whether the LLC will have a perpetual duration. Unless otherwise stated in the Operating Agreement or Articles of Organization, an LLC’s duration is perpetual (subject to events in the Operating Agreement that require dissolution) (Cal. Corp. Code §§ 17701.04(c), and 17707.01(a)).

  • 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)).

  • 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). If two or more parties are forming the LLC, there is an inherent conflict of interest. In this situation, it's important that all parties understand they have a right to seek the advice of independent and separate counsel to advise them of their individual interests.

  • The type of Operating Agreement. This could be a short-form or long-form operating agreement. Which you use depends on your particular set of circumstances. Members of LLCs 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)).

  • Whether the LLC will have majority and minority interests or whether it will be a 50/50 LLC. Minority and majority parties often have different concerns than two 50/50 members.

ARTICLES OF ORGANIZATION

To form an LLC in California, the organizers must sign and deliver the Articles of Organization to the SOS for filing. This is a vital step to the process because an LLC is formed when the SOS has filed the Articles. Although RULLCA requires only minimal information in the articles (including name, purpose, certain addresses and a management designation), the organizers should consider whether to include any additional provisions (Cal. Corp. Code § 17702.01(c)). Optional provisions should not include details regarding the membership, management, capital contributions, profit and loss allocations and distributions, meetings, termination provisions, and other particulars of the LLC's internal affairs and business operations. These should be omitted from the publicly filed Articles of Organization and instead included in the LLC's Operating Agreement because this document is private and it's likely this information is best kept as such. Also, keep in mind that if these details chaange, including them in the Articles will make amendments difficult since this will trigger the need for another filing. If the information is kept on a private internal document, making revisions is simpler.

Articles of organization must be filed using Form LLC-1, available on the SOS website (Cal. Corp. Code § 17702.01(a) and see Secretary of State: Form LLC-1). The SOS will reject Articles of Organization filed using a self-drafted form.

STATEMENT OF INFORMATION

If you're forming an LLC, you have to file a Form LLC-12 Statement of Information with the SOS within 90 days after the filing of your original Articles of Organization and biennially after that (Cal. Corp. Code § 17702.09(a) and see Secretary of State: Form LLC-12). After that initial filing and if there has been no change in any of the information contained in the previously filed Statement of Information, you can file a Form LLC-12NC Statement of No Change (Cal. Corp. Code § 17702.09(b) and see Secretary of State: Form LLC-12NC).

As for current filing fees, you can find them here: Secretary of State: Business Entities Fee Schedule). As of this writing, you'll find the fee to file the initial or a biennial Statement of Information or a biennial statement of no change by mail is $20. There is no fee to file (by mail) a Statement of Information submitted between required filing periods to report a change of information. (Cal. Corp. Code § 17702.09(c) and Cal. Gov’t Code § 12190(k), (l) and see Secretary of State: Form LLC-12). If you file in person, an additional $15 non-refundable service fee is required, which must be paid by separate check.

OPERATING AGREEMENT

A California LLC, regardless of the number of members, is not required to have a written Operating Agreement (Cal. Corp. Code §§ 17701.02(s) and 17701.11(c)). However, we recommend entering into an Operating Agreement because it will allow you to:

  • Define relationships among the members and between the members and the LLC.

  • Establish rights and duties of the managers.

  • Maintain a check on activities of the LLC and the conduct of the LLC’s activities.

If you decide to have an Operating Agreement, know that it may be entered into at any time. If the LLC is not yet formed, the parties who will be the initial members can enter into an agreement that will become the Operating Agreement when the LLC is formed (Cal. Corp. Code § 17701.11(c)).

As noted above, an Operating Agreement has a few purposes. It typically defines the LLC’s management structure, describes how to allocate and distribute the LLC’s profits, and sets out the agreements among the LLC’s members. It's sort of a combination of a corporation’s bylaws and a typical shareholders’ agreement.

When preparing the Operating Agreement, organizers should consider the rights of the members, whether the LLC will have multiple classes of membership interests, management of the LLC, initial capital contributions, how profits, loses and distributions will be allocated, the possibility of admission of new members and transfer of membership interests, and how dissolution of the LLC will be handled.

INITIAL ACTS OF THE MEMBERS OR MANAGERS

Though not required by RULLCA, some LLCs choose to pass initial resolutions of the members or managers of the LLC (similar to the initial acts of the board of directors of a corporation). If the LLC chooses to do this, consider passing organizational acts such as:

  • Adopting the operating agreement;

  • Issuing membership interests to the initial members;

  • Applying for foreign qualification in other states.

  • Adopting the fiscal year (LLCs usually operate on calendar year).

  • Opening bank accounts and authorizing signatories.

  • Electing officers (LLCs can have officers similar to corporations) (Cal. Corp. Code § 17704.07(v)).

The LLC should also address specific actions or documents the members or managers need to approve (for example, employment agreements).

Likewise, if the LLC is being formed for a specific reason or as part of a transaction (such as a merger), then it may also need to approve deal-specific agreements and documents.

POST-FORMATION MATTERS

Once the LLC is formed, there are several things to do before it can begin conducting business. We’ll address these concerns in a later blog post.

Matthew Schlau is a co-founding principal of Schlau|Rogers and an estate and business planning lawyer practicing in Orange, San Diego, Los Angeles and Riverside counties. He is a husband, father, blogger, crossfitter, and really good at helping people achieve their goals.

At Schlau|Rogers, we do more than just estate and business planning, probate and trust administration. Our objective is to provide individually-tailored plans that allow you the opportunity to reach your goals, all while minimizing headaches and risk, and maximizing peace of mind.

On our blog, you'll find useful information about estate and business planning, probate and trust administration, as well as some tidbits on personal finance, taxes, and anything else we think will help minimize headaches, worry and risk, all while maximizing peace of mind.

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