Whenever someone wants to start a new company and they come to me, I usually explain the basics of the way companies work.
Once it is decided that a sole proprietorship or a partnership is not the best option, then we discuss the differences between a corporation and a limited liability company.
In some ways the two are very similar. They are what lawyers call a “legal fiction.” That is, they exist in a legal sense, but you can’t touch them, hold them or see them.
They are a separate entity from their owners and are regulated by the state government. They are created by application to the government and so long as the name of the company is not already in use or too similar to another company in existence, the government will issue articles of incorporation or articles of organization, which allows the company to be formed.
But the question is, what is the best form for you to use. Well like tools in a toolbox, not all company forms are correct for all situations. Some types of business are more appropriate for a corporation and others are more ripe being a limited liability company.
CORPORATIONS In theory a corporation can own property, buy assets, open bank accounts, hold money, get credit and conduct business. In reality, most small corporations, meaning those under $100 million, cannot get credit on their own and you, as the entrepreneur or owner, will have to co-sign and personally guarantee any loan or credit extension that is granted to your corporation.
Protection of assets and freedom from personal liability are the benefits of a corporation and of doing business under a corporate name. But this is limited and depending on what you are trying to accomplish, a corporation may or may not be the best format for your assets.
A corporation does not need to file its name with the county in which it conducts business. It does, however, have to have its own tax ID number to open a bank account. The procedure for obtaining a tax ID is something your attorney will usually take care of as part of the services they provide in forming your corporation.
In California, corporations are registered with the secretary of state. If you have a Nevada Corporation you will need to be registered in the State of California and pay state taxes. Currently there is a minimum $800 franchise tax for doing business in the State of California.
Corporations come in two tax forms. The “S” corporation, which can only have one type of stock and requires less than 75 shareholders, is called a “pass through” entity. That means the profits and losses are “passed through” to the individual shareholders tax returns and the corporation pays no corporate tax at the federal level.
The second form is the “C” corporation, which is the default form for all corporations and requires that the corporation file and pay taxes on any profits. This has certain benefits but most entrepreneurs will want to elect “S” corporation status for all shareholders to share in the losses.
The cost of setting up a corporation should include having the attorney register the company name, get the tax ID and arrange for the stock certificates to be issued along with preparing a shareholder buy/sell agreement.
While it is true that a corporation can have its own credit, lenders usually require a personal guarantee from the corporate owner or president.
Thus, as an owner, you will be liable for the debt personally. Personal guarantees are the hidden trap of corporations.
LIMITED LIABILITY COMPANIES A Limited Liability Company once formed does not have stockholders. Instead the owners of a LLC are called members and are governed by a membership agreement. The LLC is much more flexible in its organization and it allows for different classes of ownership to exist without a great deal of formalities Like a corporation, an LLC does not need to file its name with the county in which it conducts business and it does however have to have its own tax ID number to open a bank account.
LLC’s are like the “S” corporation in that they are a “pass through” entity. That means the profits and losses are “passed through” to the individual member’s tax returns, and the LLC pays no corporate tax at the federal level. (David Pisarra is a partner in the Santa Monica law firm of Pisarra & Grist, he welcomes questions, and 310/664-9969 or emailed at)
Originally published in the Santa Monica Daily Press print edition on April 7, 2003. Read the original PDF.