Forming a Corporation in California

Is forming a corporation right for your business? There ultimately comes a time when a businessperson must evaluate whether to change the entity type of his or her business – whether to choose between a sole proprietorship and a corporation or a limited partnership and an LLC. This decision requires weighing many factors, such as tax liability, gross revenue, and number of partners involved in the business. In this post, I discuss a key protection provided to corporations. This post does not address the tax-related factors involved in deciding whether to incorporate or remain incorporated; such factors vary significantly from business to business.

Forming a Corporation in California Reduces the Owners’ Risk of Personal Liability

Forming a corporation is essentially like birthing a fictional person. The law views a corporation (and an LLC, for that matter) as a separate legal entity, that is, separate from any of its officers, directors, or shareholders. It is this legal separation between the persons operating the corporation and the corporation itself that provides an indispensable benefit: extraordinarily low risk for an owner to be held personally liable for the debts of the business. A shareholder, or owner, of the corporation can therefore receive remuneration through the company, operate the business, and hire and fire employees without placing his or her personal assets at risk. On the other hand, franchisees, or other small business owners, place their personal assets at risk when they operate as a “sole proprietorship.”

Let’s look at an example: Joe Franchisee owns a convenient store in Orange County and incorporates his business as Acme Company. Joe Franchisee is sued by a former employee for unpaid meal breaks or alleged discriminatory practices. Had Joe Franchisee been a sole proprietor, the former employee could sue Joe Franchisee and go after his personal assets. But because Joe Franchisee is the President and owner of Acme Company, only those assets held by the company are at risk. Critical – perhaps bankruptcy-preventing – difference.

To Reap the Benefits of Incorporating in California, the Owners Must Treat the Corporation as a Separate Entity

The biggest conception about forming a corporation is that it completely shields individual owners from personal liability. This is FALSE. Depending on how individual owners operate and manage the corporation, they can be held personally liable and risk exposing their personal assets. For example, an individual owner can be held personally liable for the debts of the business if her corporation does not follow “corporate formalities,” such as filing Articles of Incorporation with the California Secretary of State, adopting bylaws, maintaining corporate minutes, keeping business finances separate from personal finances, and paying all necessary taxes and fees associated with incorporating. And remember, even if the business has insurance coverage for certain types of losses, if a claim exceeds the policy, the owners’ personal assets may be vulnerable if the business is not incorporated.

So long as a business properly organizes and operates its business, the benefits of forming a corporation can prove invaluable to almost any type of business. In particular, it can mean reduced exposure of the owners’ personal assets, lower tax liability, and continuity in operating the business even upon the death of one of the owners of the business. Yash Law Group can help when making these decisions and more. Call us at 714-494-6244.