In the post-COVID economic recovery that the U.S. has been experiencing over the past year, several sub-sectors of the economy have demonstrated significant growth in particular. One unsurprising example of this has been the small business economy. Empowered by job losses and the norm of working from home, an increasingly large number of people have begun to pursue entrepreneurship as a new career choice.
This has resulted in record levels of applications for the creation of businesses, particularly in states such as California, which exhibit numerous incentives for business formation. This article will explore in more depth why it is extremely common for these businesses to be established as limited liability companies (LLCs) before discussing how to form one and the benefits of doing so.
What is an LLC?
Put simply, LLCs are a type of business structure permitted under state statutes in the U.S. that new businesses can elect to form. The two key features of LLCs that are worth noting are their limited liability protection and pass-through taxation. By amalgamating these two attributes, which are specific to corporations and partnerships respectively, LLCs act as a hybrid option that blends two of the biggest positives for small businesses.
Since statewide laws manage LLCs, the specific rules that apply to them differ quite significantly between each state. This is why, despite it being quite simple to understand how LLCs are generally formed, it is pivotal that entrepreneurs wishing to form in a particular state engage in research concerning that state’s guidelines.
For the sake of simplicity, a few confusing details about LLCs will be expounded here so that the later parts of this article can be understood. Firstly, the term ‘members’ is used to describe the owners of an LLC, and the parties that can fill the role of an LLC’s members are not restricted in many states.
The result of this is that it is completely normal for LLCs to be owned by a number of different parties, including individual entrepreneurs, other business structures, foreigners, and sometimes other LLCs.
How to start an LLC in California
As explained above, the regulations managing the creation of LLCs vary in each state, which is why it is important for people hoping to start a business in California to be aware of this specific state’s requirements.
LLC name
The first part of applying for the creation of an LLC is relatively straightforward – simply choosing a name that is not already taken. It is a requirement of LLCs in California that their business name is ‘unique’, which simply means that it (and nothing that is a very slight variation of it) is not already in use by a registered business in California.
This can be verified with a quick business name search on the California Secretary of State’s website. The second naming requirement to note is that an LLC must end with what California law refers to as a “proper designator”. This simply means finishing with the words ‘LLC’ or any of a number of slight variations of this term.
Registered agent
The next thing that is needed for the creation of a business is a registered agent that resides in California. A registered agent has just one job—to receive documents on behalf of the business and pass them on to the appropriate person at the business. Once you’ve chosen a registered agent, you can tell the agent who to notify if they receive lawsuits or other documents.
Articles of Organization
Next, a form called the ‘Articles of Organization’ must be filed with the State of California. This form is necessary because each state has its own established requirements regarding the licensing and zoning requirements for LLCs. These forms just ensure that all LLCs formed in that state abide by these administrative requirements from the moment they are created.
Operating agreement
While not required by law, many professionals highly recommend LLCs create an operating agreement. The purpose of this purely internal document is to keep a record of who is listed as a member, their ownership percentages, and a number of other important details regarding how the LLC will be managed.
Employer Identification Number (EIN)
The Internal Revenue Service (IRS) distributes EINs to LLCs. These numbers are essentially social security numbers for businesses. They are necessary for LLCs to open bank accounts, file taxes, and handle a number of other financial necessities.
There is no cost associated with obtaining an EIN, the form to do so can be filled out for free on the IRS’s website.
Statements of Information
An Initial Statement of Information must be submitted by all Californian LLCs within 90 days of their formation. This only costs $20 and is relatively easy to complete, either online, by post, or in person.
Following this, an Ongoing Statement of Information must be filed every two years as well, the deadline being the formation date of the LLC.
Franchise tax
Irrespective of an LLC’s total revenue (i.e. even if it made nothing or less!), an LLC based in California is liable to pay Annual Franchise Tax to the California Franchise Tax Board. This tax is unavoidable for LLCs in California.
LLCs earning in excess of $250,000 a year in gross revenue is liable to pay an Estimated Fee on top of this.
Benefits of LLCs
There are two primary reasons entrepreneurs are attracted to LLCs: personal asset protection and their flexibility. There are periphery benefits associated with LLCs, such as their comparatively straightforward startup process and reduced restrictions on ownership, but since these are normally added benefits to the choice to form as an LLC, they will not be outlined in much depth.
With added flexibility, LLC members are able to focus and deviate their time to various important tasks to ensure all operations are running smoothly within the business. Personal asset protection can give owners peace of mind should something go wrong. On top of everything, there are so many free resources and paid formation services for entrepreneurs to refer and turn to should they need help to establish their LLC. The benefits provide a whole range of opportunities.
Our thoughts
It is easy to understand why LLCs are such a popular business choice among entrepreneurs and small business owners, though many are deterred by their perceived difficulty in the process of forming an LLC. Evidently, with the correct resources, forming an LLC in California is incredibly simple and straightforward.
More information on how to form a California LLC has been provided by LLC University.
