So, Maybe California is NOT The Best Place To Incorporate Your Business?

Anybody who has ever studied corporate law will tell you that “forum shopping” is one of the first things you are taught.  Forum shopping means that you deliberately incorporate or organize your business in a state whose laws are favorable to you.  After all, the laws of the state in which you incorporate determines the organization and internal affairs and the liability and authority of the owners and executives, etc..  For many large corporations, that state is most often chose is Delaware.  From my personal experience, most small business owners bypass the whole forum shopping process altogether and simply incorporate or organize in the state that the owner(s) live or the state where the company primarily operates. 

Well, according to Jaia Thomas, it might be time for some small business owners to do a bit of forum shopping instead of choosing to incorporate in California by default. She lists 3 reasons why California might put you at a disadvantage:

1)    The Highest Franchise Tax

a)    If you form an LLC in California, you must pay a minimum franchise tax of $800.  

i)    This is the highest in the U.S. and California is “the only state to impose a minimum franchise-tax flat fee”

ii)    In some other states, the amount of franchise tax you pay is contingent on gross profit and revenue.  California does not allow for this;

iii)    You must pay the franchise tax whether or not your business is active, inactive or operates at a loss;

iv)    Failure to pay the franchise tax will result in suspension of your LLC and hefty fines.

v)    California is the 3rd worst state for business taxation.

2)    Limited LLC offerings

a)    Many states are offering different types of LLCs but California is lagging behind. (Thomas highlights the Series LLC that is NOT offered in California)

i)    The Series LLC is one in which “a master limited liability company's organizing documents allow for separate subunits (or a series) that operate as independent LLCs”;

ii)    Each series can “have a separate business purpose and distinct rights, powers, duties and allocations of profits and losses”;

iii)    One filing allows you to run several corporations;

iv)    States like Texas and Illinois offer this type of LLC.

3)    You Have To Pay Special Attention To Your Operating Agreement

a)    The new California Revised Uniform Limited Liability Act (enacted in January 2014) imposes a lot more regulations on California LLCs.

i)    Now operating agreement must OPT OUT (i.e . members must expressly state in agreement that they choose to do things differently than the default allowed under the new law.

ii)    For example: now you need unanimous consent from LLC members for “selling, leasing, exchanging or disposing of all or mostly all the LLC’s property outside the ordinary course of business”;

•    Under previous act unanimous member consent  was required “only for amendments to the articles of organization and the operating agreement”

iii)    If you want to opt out of these new regulations you now have to be extra careful when drafting your operating agreement.


Note However you might want to stay with California if you are worried about costs:

According to Tamara L. Harper,

“There may be additional filing fees and annual maintenance fees, and the expense of maintaining an agent for service of process in the state of organization. Further, the practitioner must learn and keep abreast of the law of the foreign jurisdiction, and the client may need to engage local counsel.”

So, in the end, it’s up to you to balance the costs and benefits of choosing the Golden State.

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Posted on October 2, 2014 and filed under Start-up.