Q. What is a sole proprietorship and how is that business entity formed?
A. A sole proprietor is an individual who does business. You are your business. This is a simplest and least expensive form of doing business. The individual is the business. He is the sole owner and is 100% liable for all the debts of the business. The sole owner is also the sole taxpayer. One typically only needs a business license and then he can commence the business (there may also be special licensing requirements for certain vocations and professions and also if selling products there may also be other requirements such as a seller’s permit, health and safety certificates, etc.) If the individual does business under a name other than his own (e.g., Bonehead Bodywear) or the business name implies more than one owner (e.g., Johnson & Sons), the sole proprietor is required to record a fictitious business name through the county recorder’s office in the county of the principal place of business and publish that fictitious name in a newspaper of general circulation. See http://sdpublic.sdcounty.ca.gov for more information.
Q. What is a general partnership and how is that business formed?
A. A general partnership is an association of two or more persons to carry on as co-owners in a business for profit, whether or not the persons intend to form a partnership. (Cal. Corp. Code § 16202(a).) This is a very broad standard for creating this type of business, simply two or more persons (can be corporations and/or limited liability companies) engaged as owners in a common business enterprise to earn a profit—even if they don’t earn any profit. A general partnership can be formed orally, by conduct and/or in writing. Each partner is 100% liable for the partnership’s debts and for the acts of the other partner(s), acting in the course and scope of the partnership business. There are no special filings to create this type of business entity (though, as mentioned above, there may be vocational or professional licenses or other permits or certificates required to actually operate as a business). The partnership has an independent existence; it can own property; it can sue and be sued. In a partnerships all income earned by the partners is passed through and taxed to the individual partners. While an oral partnership agreement is enforceable, there are always questions of proof; therefore, we strongly recommend that you hire legal counsel if you intend to form a general partnership. A family partnership is typically a general partnership. There are many other issues that arise in a general partnership and you are strongly cautioned to consult with us to address particular issues.
Q. What is a limited partnership and how is that business formed?
A. A limited partnership consists of one or more general partners (having the rights of general partners in a partnership) and one or more limited partners (having limited liability and no—or very limited—right to be involved in any management and control of the business of the limited partnership). The most important feature of a limited partnership is the limited partner enjoys limited liability as long as he or she does not participate in the control of the partnership business. The general partners of the limited partnership are the ones who are responsible for the obligations of the limited partnership. In California, a limited partnership is a creature of statute and begins with the filing of a LP-1 with the Secretary of State and paying the appropriate fee. The necessary form can be obtained at http://www.sos.ca.gov/business. Registration of a limited partnership with the California Secretary of State will obligate a limited partnership to pay to the Franchise Tax Board an annual minimum tax of $800.00. The tax is required to be paid for the taxable year of registration and each taxable year, or part thereof, until a Certificate of Cancellation is filed with the California Secretary of State. There are name requirements to be aware of, including, but not limited to, a California requirement that the name must include “Limited Partnership” or LP or L.P. Because limited partnership interests create securities issues, you are strongly cautioned to consult with us to address particular issues.
Q. What is a limited liability partnership and how is that entity formed?
A. A limited liability partnership (“LLP”) is a form of ownership in which all the partners receive limited liability protection. However, an LLP is similar to a general partnership in that all the partners can take an active role in managing the day-to-day affairs of the business. The LLP form of ownership is limited in the State of California to persons licensed to practice in the fields of public accountancy, law, or architecture. In order to form in California, an LLP must first register with the California Secretary of State by filing an LLP-1 form and paying the appropriate fee. An LLP formed in another state must register with the California Secretary of State prior to conducting business in the state. Registration of a limited partnership with the California Secretary of State will obligate a limited partnership to pay to the Franchise Tax Board an annual minimum tax of $800.00.
Q. What is a corporation and how is that business formed?
A. In a general sense, a corporation is a business entity that is given many of the same legal rights as an actual person. Corporations may be made up of a single person or a group of people, or entities, known as sole corporations or aggregate corporations, respectively. Corporations exist as virtual or fictitious persons, granting a limited protection to the actual people involved in the business of the corporation. This limitation of liability is one of the many advantages to incorporation, and is a major draw for smaller businesses to incorporate; particularly those involved in highly litigated trades. A corporation may issue stock, either private or public, or may be classified as a non-stock corporation. If stock is issued, the corporation will usually be governed by its shareholders, either directly or indirectly. The most common model is a board of directors which makes all major decisions for the corporation, in theory serving the best interests of the individual shareholders. Generally there are three major types of corporations: Close, C, and S. In California, a corporation is created with the filing of the Articles of Incorporation. The necessary form can be obtained at http://www.sos.ca.gov/business. Registration of the corporation with the California Secretary of State will obligate the entity to pay to the Franchise Tax Board an annual minimum tax of $800.00. The corporation also must continue to comply with corporate formalities to keep its status and to protect the owners from personal liability.
Q. What is the difference between a C corporation and an S Corporation?
A. A C corporation is a general business corporation. The corporation is a separately taxed entity. A corporation initially is a C corporation and must specifically elect S status. S corporations receive that designation by making an election (timely filing an IRS 2553 form) to be taxed not as the corporation but to have all the income earned by the corporation pass through to the individual shareholders (owners) so that the individuals only pay tax on the income earned. Small closely held businesses with owners involved in the day-to-day operations typically elect S status. The S corporation has restrictions on ownership: there is a 100 shareholder limit; shareholders must be US citizens or permanent residents; only one class of stock is allowed; no more than 25% gross income may come from passive income. A C corporation does not have such restrictions on the number of or type of shareholders. A C corporation is typically used in anticipation of institutional and/or third party investment (venture capital, private equity investors, strategic partners, etc.)
Q. What is a limited liability company and how is that entity formed?
A. A limited liability company is a type of business organization that combines some aspects of a corporation with those of a sole proprietorship or partnership. As in a corporation, the personal liability of the company's members for the business's debts is limited — hence the name; unlike in a corporation, however, a limited liability company is not taxed as a separate entity, but the income is passed through and taxed to the individuals. The limited liability company is a relatively new innovation in the United States, intended as a way to help small businesses gain many of the benefits enjoyed by corporations, while allowing them to retain their small business model of ownership. A traditional corporation requires a number of formalities that a limited liability company does not need. Corporations have shareholders, for example, and must meet a certain number of times per year at shareholder meetings to make decisions. A limited liability company does not have shareholders (it has members) and does not require meetings. Similarly, a limited liability company (“LLC”) does not need bylaws, though some states, including California, require an operating agreement in order to recognize the company. While the formalities are relaxed some for an LLC, there are still formalities that must be met for the entity to retain its status and to protect the members from personal liability. The management structure in an LLC is very flexible: the entity can be member managed or manager managed; it can be managed like a corporation (with officers and directors); it can be managed like a partnership or even a sole proprietorship. In California, an LLC is created with the filing of the Articles of Organization. The necessary form can be obtained at http://www.sos.ca.gov/business. Registration of the LLC with the California Secretary of State will obligate the entity to pay to the Franchise Tax Board an annual minimum tax of $800.00 and a fee based on the annual total income of the entity. There are name restrictions with California LLCs. An LLC is often the entity of choice for real estate development and investment, when clients seek pass-through tax benefits, with offering different levels of ownership. The entity is attractive to individuals and non-institutional investors. There are other issues to consider with an LLC, so we encourage you to contact us for a free consultation.
Q. Can all business types be LLCs in California?
A. No. A domestic or foreign LLC may not render professional services. (Corp. Code §17375.) “Professional services” are defined in California Corporations Code sections 13401(a) and 13401.3 as: Any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, the Osteopathic Act or the Yacht and Ship Brokers Act. You should consult us regarding whether your particular business can be an LLC.
Q. What is a non-profit organization and how is that entity formed?
A. A non-profit organization is a group organized for purposes other than generating profit and in which no part of the organization's income is distributed to its members, directors, or officers. Non-profit corporations are often termed "non-stock corporations." They can take the form of a corporation, an individual enterprise (for example, individual charitable contributions), unincorporated association, partnership, foundation (distinguished by its endowment by a founder, it takes the form of a trusteeship), or condominium (joint ownership of common areas by owners of adjacent individual units incorporated under state condominium acts). Non-profit organizations must be designated as nonprofit when created and may only pursue purposes permitted by statutes for non-profit organizations. Non-profit organizations include churches, public schools, public charities, public clinics and hospitals, political organizations, legal aid societies, volunteer services organizations, labor unions, professional associations, clubs, research institutes, museums, and some governmental agencies. Non-profit entities are organized under state law.
The three primary types of nonprofit corporations, namely, religious, public benefit and mutual benefit, are described below.
1) A corporation organized to operate a church or to be otherwise structured for primarily or exclusively religious purposes is a nonprofit Religious corporation.
2) A corporation organized primarily or exclusively for charitable purposes and which plans to obtain state tax exempt status under California Revenue and Taxation Code section 23701(d) and/or federal tax exempt status under Internal Revenue Code section 501(c)(3) or organized to act as a civic league or a social welfare organization and which plans to obtain state tax exempt status under California Revenue and Taxation Code section 23701(f) and/or federal tax exempt status under Internal Revenue Code section 501(c)(4) is a nonprofit Public Benefit corporation.
3) A corporation organized for other than religious, charitable, civic league or social welfare purposes and planning to obtain tax exempt status under provisions other than California Revenue and Taxation Code sections 23701(d) and 23701(f), Internal Revenue Code section 501(c)(4), or not planning to be tax exempt at all, is a nonprofit Mutual Benefit corporation.
State law governs solicitation privileges and accreditations requirements such as licenses and permits. Each state defines non-profit differently. Some states make distinctions between organizations not operated for profit without charitable goals (like a sports or professional association) and charitable associations in order to determine what legal privileges the respective organizations will be given.
For federal tax purposes, an organization is exempt from taxation if it is organized and operated exclusively for religious, charitable, scientific, public safety, literary, educational, prevention of cruelty to children or animals, and/or to develop national or international sports. Social security tax is also currently optional although 80 percent of the organizations elect to participate.
After incorporation under state law, the corporation needs to timely seek tax exemption by filing appropriate forms with the IRS (e.g., Form 1023) and the appropriate state entity forms (e.g., California Franchise Tax Board 3500 or 3500A).
We form and advise non-profit entities; therefore, we encourage you to consult with us.
Q. Where should the entity be formed?
A. Popular domiciles for the business entity include Delaware, Nevada, Wyoming and California. With a small or closely held corporation or LLC doing business in California, many times California is the best choice of domicile. However, if the entity’s business is not necessarily limited to California or anticipates third party investors, other states such as Delaware or Nevada as the place of incorporation should be evaluated.
Q. Why not use an internet based “do it yourself kit” to form my corporation, LLC or partnership?
A. There are various services you can use on the internet to incorporate or form your business. The price may be much lower than hiring a lawyer. While many of the “do it yourself” kits provide some basic knowledge and form documents, the difficulty is often the “form” documents do not necessarily apply to your particular situation. Moreover, many times, the service does not give you a complete understanding of your on-going obligations regarding the business (formalities, government filings, how to act like a corporation, etc.) An improperly formed corporation or LLC potentially exposes the individual owners to personal liability—which was one reason for forming the entity in the first place. We find that many “self” incorporated businesses need professional help fixing the things not done or wrongly done and you end up spending more money than if you went to a lawyer in the first place. Plus, we believe there is a certain comfort level in being able to personally consult with a lawyer during and after the formation process, which you do not get with an internet or mail order service. As in most areas of business, this warning seems apropos: caveat emptor, i.e., let the buyer beware.
Q. What is a buy-sell agreement and why consider one?
A. A buy-sell agreement is a contract that provides for the future sale of your business interest or for your purchase of a co-owner's interest in the business. Buy-sell agreements are also known as business continuation agreements and buyout agreements. These types of agreements typically are used in closely held, or smaller, businesses with few shareholders, partners or members. Under the terms of a buy-sell agreement (assuming you are the seller), you and the buyer enter into a contract for the transfer of your business interest by you (or your estate) at the occurrence of a specified triggering event. Typical triggering events include death, dissolution, divorce, disability, and retirement. Ideally, buy-sell agreements are fully funded, and life insurance is frequently used for this purpose. After determining the value of the business, you, your advisors, and the other parties to the agreement will determine the best way to fund the transaction, and the triggers appropriate for your business situation. If you own a business and are concerned about how the death of a co-owner might affect its operation, a funded buy-sell agreement can help by ensuring that you will be able to purchase your partner's share, eliminating any doubts about the continuation of the business. You can also avoid the dilemma of being in business with your partner's survivors. There are also costs and possible disadvantages involved in establishing a buy-sell agreement. One such disadvantage is that the agreement typically limits your freedom to sell your business interest to outside parties. If you think that a buy-sell agreement might benefit you and your business, contact us and a financial professional about the pros and cons of setting one up.
Q. How can I raise money for my business?
A. A business can obtain money through debt financing (such as a bond or note) or equity financing (stock, or membership unit/certificate, issuance or sale of a partnership interest). Private funding or venture capital may be used to support new businesses and speculative ventures, usually businesses with high growth potential. A typical venture capital investment usually involves the business owner giving up equity (in the form of a share in the business) to the venture capitalist in return for funding. A strong business plan and the possibility of better-than-average returns are usually key components in the decision of a venture capital firm to fund a business start-up.
There may be significant securities issues accompanying a stock, bond or membership issuance, so you should consult us to assist in this process.
Q. How can I protect my business and trade secrets when I talk to investors or others about financing or other assistance (or even hire employees or independent contractors)?
A. Confidentiality agreements, sometimes called secrecy or nondisclosure agreements, are contracts entered into by two or more parties in which some or all of the parties agree that certain types of information that pass from one party to the other or that are created by one of the parties will remain confidential. Such agreements are often used when a company or individual has a secret process, a new product or other confidential information that it wants another company to evaluate as a precursor to an investment, joint venture or comprehensive licensing or distribution agreement. Or, perhaps one party wants to evaluate another's existing commercial product for a new and different application. Or, sometimes employers want to keep their confidential information from being used in competition by employees or independent contractors working for the business.
Confidentiality agreements perform several functions. First and most obviously, they protect sensitive technical or commercial information from disclosure to others. One or more participants in the agreement may promise to not disclose technical information received from the other party. If the information is revealed to another individual or company, the injured party has cause to claim a breach of contract and can seek injunctive and monetary damages.
Second, the use of confidentiality agreements can prevent the forfeiture of valuable patent rights. Under U.S. law and in other countries as well, the public disclosure of an invention can be deemed as a forfeiture of patent rights in that invention. A properly drafted confidentiality agreement can avoid the undesired—and often unintentional—forfeiture of valuable patent rights.
Third, confidentiality agreements define exactly what information can and cannot be disclosed. This is usually accomplished by specifically classifying the nondisclosible information as confidential or proprietary. The definition of this term is, of course, subject to negotiation. As one would imagine, the company or individual disclosing the confidential information (the "discloser") would like the definition to be as all-inclusive as possible; on the other hand, the company receiving the confidential information (the "recipient") would like to see as narrowly focused a definition as possible.
The type of information that can be included under the umbrella of confidential information is virtually unlimited. Any information that flows between the parties can be considered confidential—data, know-how, prototypes, engineering drawings, computer software, test results, tools, systems, specifications, marketing and financial information and customer or client lists. This list is certainly not exhaustive but does illustrate the breadth of items that can be deemed confidential.
Most confidentiality agreements exclude certain types of information from the definition of confidential information. It is very important that the recipient include these exceptions in the confidentiality agreement. Some commonly employed exceptions are information that the recipient can demonstrate that they had prior to receipt of information from the discloser, information that becomes known to the public through no fault of the recipient, information that becomes known to the recipient from a third party that has a lawful right to disclose the information, information that was public knowledge before the disclosure of the information to the recipient, and information independently created by the recipient.
In sum, there are several situations where a confidentiality agreement is appropriate and may be proposed. Knowing a few basic points discussed above concerning confidentiality agreements can ensure that the important purposes they serve will not be defeated by ambiguities or ignorance of the meaning of terms used in the agreement. A consultation with us and a well drafted non-disclosure agreement are essential in this area.
Q. What is a covenant not to compete contract provision and is it enforceable in California?
A. A covenant not to compete, also called a non-competitive or restrictive clause, is a formal agreement which prohibits one party from competing in, or performing, the same or similar business within a designated area for a specified amount of time.
Unlike many states, California law generally prohibits covenants not to compete except in very limited circumstances. California Business and Professions Code section 16600 provides that, with certain limited exceptions, “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”
As such, California employers must be cognizant of the fact that termination of an employee who refuses to sign an employment agreement containing an illegal covenant not to compete constitutes wrongful termination in violation of public policy.
The state recognizes an exception to this general rule where non-compete agreements are entered into in connection with the sale of the goodwill of a business or the shares or assets of a corporation. This exception can be found in Business and Professions Code section 16601 and is based on the fact that a company’s value would be worth considerably less if a buyer could not be assured that the seller would not simply open up a new shop right next door to the one he sold. For similar reasons, partnership agreements may include noncompetition clauses as part of the dissolution process. Of course, covenants not to compete must also be reasonable in geographic and temporal scope, which may depend on the particular facts and circumstances surrounding a given non-compete agreement.
In addition to these exceptions, some restrictive clauses narrowly drawn may be enforceable, such as some non-solicitation clauses, prohibiting competition during employment and restrictions on using trade secret or confidential information to compete. For these and other contract issues, you should consult with us.