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Dispelling Business Formation Myths

Ralph G. Martinez June 28, 2021

Forming a business can present many unique challenges, starting with establishing the entity – sole proprietorship, partnership, or corporation that would most closely meet the goals and needs of the proprietors.

Many questions will likely arise over liability and, if more than one person is involved, over organizational structure and leadership roles.

The more concrete and detailed the planning when forming a business, the better your chances of avoiding pitfalls and disputes, and if they do arise, the better prepared you are to deal with them.

At Martinez Law Office, I have been helping people launch their businesses on solid legal footing for four decades. I have addressed their questions and concerns and given them the answers and legal tools they need to confidently move forward. I serve clients in and around Santa Ana, California, and throughout the surrounding counties of Orange, Los Angeles and San Diego.

Common Concerns When Starting a Business

Through the decades, I have become accustomed to hearing concerns voiced by entrepreneurs that seem to cut across industries and generations. Let me deal with some of those concerns here. Common myths include:

Myth #1: Choosing a Business Entity Is Only Important for Large Businesses

The biggest questions in choosing a business entity revolve around money and liability. For instance, certain business formats shield the principals from liability for debts or judgments against them, while others leave the owner or owners personally liable. Some formats also make it easier to obtain money in the form of investors, shareholders, or bank loans.

In general, sole proprietorships and partnerships provide the least liability protection – usually none – for the owners or partners, though Limited Partnerships (LPs) do offer liability protection. It is also harder for a sole owner to obtain bank funding, and they often have to resort to personal savings, retirement accounts, or refinancing their personal residences to raise capital. Partners may face the same difficulty.

A corporation or a Limited Liability Company (LLC) provides much greater personal liability protection against debts, claims, and lawsuits. Corporations, but not LLCs, can also sell shares to raise operating funds. Unlike the other business formats, corporations pay taxes as a separate entity and profits and losses do not flow to the incorporators.

So, really, choosing a business format — sole proprietorship, partnership, LLC, corporation — boils down to liability and the ability to obtain funds when needed, and has little correlation to size of the operation. Many professionals like doctors, accountants, and attorneys operate as LLCs or corporations even though they practice alone.

Myth #2: You Have to Be a U.S. Citizen to Form an LLC

In California, you can easily form a corporation or LLC if you are a non-resident. California does not restrict non-U.S. residents or foreign companies from doing business in the Golden State. Non-residents and foreigners must follow the normal procedures established by the Secretary of State (SOS) for incorporating or forming an LLC, but in addition, they must appoint a registered agent with a valid physical address in the state. That is one additional requirement.

Myth #3: Incorporation Provides Absolute Liability Protection

Forming a corporation provides the incorporators with broad liability protections against debts and legal actions, provided the corporation operates for a legitimate business purpose.

If a corporation, however, is used to perpetuate a fraud, circumvent a statute, or accomplish some other wrongful or inequitable purpose, the courts can disregard the corporate form and view the entity as an association of individuals, who can then be held liable. This is called “piercing the corporate veil.”

Myth #4: You Won’t Have to Pay Taxes If You Incorporate in Another State

Whether you incorporate in Nevada or Delaware, two states with favorable incorporation protections and tax structures, you still must pay taxes and honor California employment and other applicable laws if you do business in the state. The standard is whether you’re “doing business” in California. Courts have held that even businesses physically located outside California but having employees working here are subject to California laws and taxes while those employees are working in the state.

Myth #5: LLCs Can Be Publicly Traded

Limited Liability Companies, or LLCs, are basically a private ownership arrangement. Unlike a C or S corporation, they cannot issue stock, that is, cannot have shareholders. Although it can be difficult, an LLC can issue a bond, which is similar to issuing stock. A more likely avenue, if amenable to the LLC members (owners), is to raise capital by selling a portion of the company to family members or friends.

Let Martinez Law Office Help

With my 40 years of experience in helping others form businesses and representing them in court when things go sour, I can listen to your goals and aspirations and help you choose the proper entity for your business, whether partnership, LLC, corporation or other. I will also work closely with you to get all the necessary legal protections and documents in place for the seamless launch of your enterprise. You can rely on me as your trusted advisor.

If you’re looking to start a business in or around Santa Ana, including Orange and the neighboring counties of Los Angeles and San Diego, contact Martinez Law Office immediately. I can assist you with your business formation questions, no matter where you're from.