Legal Issues

3 Reasons to Not Form a Company in California

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Every year thousands of new companies are incorporated in California. As the nation’s most populous state at 38 million people, California is home to such companies as Walt Disney and Adobe. Despite California’s appeal and allure, forming a company in the Golden State comes with some disadvantages.

Here are three: 

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1. The franchise tax.

Those thinking of forming a limited liability corporation in California should note that the California Franchise Tax Board imposes a minimum franchise tax of $800 on every company that's incorporated in the state.

While a handful of other states such as Arkansas require companies to pay an annual franchise tax, California’s minimum $800 franchise tax fee is the nation's highest. A California company must pay this tax whether it's active, inactive or operates at a loss. Companies are required to remit payment within the first four months of formation and every year after. Failure to pay the $800 franchise tax each year can result in a company's suspension as well as hefty penalties.  

While other states impose franchise taxes, California is the only state to impose a minimum franchise-tax flat fee. Also, while other states' franchise taxes are contingent on such factors as gross profits and revenue, California doesn't allow for any exceptions or contingencies concerning the imposition of a franchise tax.  

The Tax Foundation’s 2014 State Business Tax Climate Index ranked California as the third worst state for business taxation, noting California’s relatively high rates. 

2. Limited LLC offerings.

Gone are the days of standard limited liability companies. Some states are setting up statutes that allow for a range of limited liability companies. One type of limited liability company that's popular is the series LLC: This setup arises when a master limited liability company's organizing documents allow for separate subunits (or a series) that operate as independent LLCs. Although several states such as Texas and Illinois allow for series LLCs, California does not. 

Each series within a LLC might have a separate business purpose and distinct rights, powers, duties and allocations of profits and losses. A series LLC has a flexible structure and reduced administrative costs. This business structure lets entrepreneurs run several different operations under the framework of one LLC after filing only a single articles of organization (as opposed to several).

Series LLCs are popular among entertainment and tech firms, two types of companies critical to California’s economy. While other states have begun to broaden their LLC offerings, California still lags behind.

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3. Unanimous consent requirement.

In January, California enacted a new limited liability company act. The California Revised Uniform Limited Liability Act imposes a bevy of new rules and regulations.

Unless expressly stated otherwise in an LLC’s operating agreement, the law requires members' unanimous consent for carrying out the following activities: selling, leasing, exchanging or disposing of all or mostly all the LLC’s property outside the ordinary course of business. 

The new law requires LLC managers and members to be a lot more meticulous in drafting their operating agreements. Otherwise, LLCs will be subject to many more requirements.

Before the passage of the new act, unanimous member approval was required only for amendments to the articles of organization and the operating agreement. 

While an operating agreement can override these rules, members and managers must be careful to ensure it does.Otherwise, they run the risk of having their company subject to a number of new regulations. Entrepreneurs thinking of forming an LLC in California are advised to consult the new law beforehand.

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