Thursday, November 17, 2011

Why file your corporation or LLC in California

I received a question about filing for a business outside of California. While I agree that paying $800 year for a small business is ridiculous, the solution is not becoming a foreign (out-of-California) entity. I'll explain below, but the best solution sometimes a simple proprietorship or partnership. Here's why.

Any limited liability entity headquartered in California needs to register in California.
1) Filing in California gives you the privilege of enforcing your contractual rights in California. A court will dismiss a non-registered plaintiff because the privilege to enforce your contractual rights is in the state of the headquarters, as documented by the Articles.
2) California requires entities doing business in California but registered outside of California to file as a foreign entity. The filing expenses are the same and this provides full rights (including name protection through registration), but at the same annual cost of income tax (Franchise Fee). A foreign entity can omit the foreign entity registration if its operations in California are insubstantial, as by being transient or without an instate office, officers, or employees. If a person with the entity lives and conducts business for the entity in California, it qualifies as a foreign entity. Another way of thinking about registration is whether the entity is active in California. If the assets and operations are in another state, foreign entity registration is less likely a requirement.
3) While its true that other states do not require disclosure of officer names, a good sleuth can get the names without a lot of effort.
4) In every state, you must name an agent for service of process. Outside of California, that means 'hiring' a company to have a doorway and a person inside the door during regular business hours. The job of the person is to receive lawsuits and notices. The job of the person is NOT to make sure you receive the lawsuit or notice. An entity is subject to a default judgment and registration suspension if the entity fails to timely and properly reply.
5) Some states require you to effectively include portions of the operating agreement (bylaws) in your articles. This can tell people far more about your company than the company name, and require significant effort making sure the articles comply with the requirement.
6) California is comparatively lax about how the owners run the entity. Don't commit fraud, or break financial or security laws, and you are OK. Other states tell you how to run your business and require these statements in your articles or operating agreement.
7) Lastly - failure to register in California may result in substantial fines based on income and the minimum franchise fees.

As to non-registration (a simple partnership):
The usual goal of small business registration is limited liability. Liability arises from contractual obligations or negligence. If the business hasn't signed contracts of obligation and is not yet providing a product or service, the risk of liability is basically the same as having a hobby. If an obligation would risk more than you have on-hand to fulfill the obligation, then limited liability is warranted. Otherwise- what is there to worry about? If at some time you must register and quickly, there are ways to get registration within a week or two for the expense of a few hundred dollars, which is much less than the annual minimum franchise fee.

Also - many insurance companies offer errors and omission insurance. O&E covers you for business losses based on circumstances outside your control, generally including simple negligence, and some contractual obligations based on the policy. You are not covered for gross or intention negligence, fraud or breaking financial or security laws - but then limited liability does not cover those either.

Lastly - if you want name or brand protection, the filing of a city business license, county fictitious statement, and state and federal trademarks decently provide that protection. Caveat - the California Secretary of State does not crosscheck the business entity and trademark registrations. You get that security ONLY by registration.