This articles contains information provided as a service to help people understand starting and running California Limited Liability Companies.
Forms and instructions for many of the topics discussed on this page can be obtained by downloading forms at the California Secretary of State website.
Formation and Operation of an LLC in California
This section provides an outline of key considerations with respect to forming and operating a limited liability company in California. Features are similar in other states.
The limited liability company entity is a relatively new form of business organization to California. The authorization of the LLC form of business in California is intended to provide flexibility to businesses for meeting their objectives. Advantages of the LLC legal structure are its protection of personal assets and credit reputation of business owners.
A limited liability company combines some of the best characteristice of the partnership and corporation while eliminating some of the of their less desirable characteristics. The owners (called members) of a limited liability company, like shareholders of a corporation, are not personally liable for the debts of the business. Yet, like a partnership, double taxation is avoided because the profits of the company are not subject to income tax.
Members of a limited liability company may actively participate in management without becoming subject to personal liability. The members of an LLC enjoy significant freedom under California law to fix their rights and obligations by agreement as to most matters.
Organizing a Limited Liability Company
One or more persons may form a limited liability company by signing and filing articles of organization with the California Secretary of State. If the members conduct business prior to filing the articles of organization, they run a substantial risk of being treated as partners to a greneral partnership with personal liability imposed on every owner for debts incurred prior to legally registering the Limited Liability Company.
Articles of Organization
One or more persons may form a limited liability company by signing and filing articles of organization with the California Secretary of State.
Nothing else is required to start the LLC’s legal existence. The limited liability protection created by the limited liability company structure begins on day one.
California Articles of Organization are uncomplicated. The form required by the Secretary of State (Form LLC-1) requires basic information about the limited liability company for it to be approved. The mandatory information includes:
- 1. The name of the California Limited Liability Compmany;
- 2. The company’s Business Address;
- 3. The agent for service of process. The registered agent can be an individual or a corporation that is approved as a Registered Corporate Agent. If the agent is not a corporation, the agent’s California street address is required on the Articles of Organization.
- 4. If the LLC will be managed by:
- “One manager”, “More than One Manager” or “All LLC Member(s)”;
- 5. The following Purpose Statement
“The purpose of the limited liability company is to engage in any lawful act or activity for which a limited liability company may be organized under the California Revised Uniform Limited Liability Company Act.” Any other purpose statement will be rejected;
- 6. The name and signature of the Organizer. The Organizer is the person responsible for filing the articles and communicating with the Secretary of State until the registration is approved.
- Other provisions can be added to the LLC-1 Form by attaching an exhibit.
Create an Operating Agreement
Provisions of an operating agreement function to setup how an LLC will be run.
The members in a limited liability company customarily enter into an operating agreement at the time the articles of organization are filed. The purpose of the operating agreement is to describe the members’ financial responsibilities, management rights, profit and distribution shares. If the members do not define their rights and obligations in an operating agreement, California law will supply any missing rights or obligations in a manner which may or may not be consistent with the members’ expectations.
Management Rights and Control
The Operating Agreement designates how the LLC will be managed. California allows a limited liability company operating agreement to divide management rights and responsibilities among the members or to grant management rights and responsibilities to “managers” elected by the members. Elected managers do not have to be members of the LLC.
If an LLC is managed by one or more managers, the LLC’s members are not involved in the day-to-day management of the company’s business. If a member becomes concerned that the managers may not have taken the necessary steps to enforce a claim of the limited liability company against a third party, each member has a special right to bring a legal action (called a “derivative action”) to obtain a judgment in the name of the limited liability company against the third party.
Allocation of Profits and Losses
Allocation of profits is significantly more flexible with an LLC versus a Corporation. The members to a California LLC have the ability to allocate profits and losses in any manner they choose. If the members do not allocate distributions in their operating agreement, California law provides that distributions will be shared by the members in proportion to their actual contributions to the limited liability company and, after all contributions have been returned, distributions will be shared equally by the members.
Capitalization and Debt Financing
California law gives members broad discretion to determine among themselves how cash, other property, or services will be contributed to the limited liability company by each member at the time of formation or at any time thereafter.
California LLCs can borrow money from its members or from third parties. The financial condition of a member is not normally taken into account by a lender, except to the extent that the lender is relying upon the member’s initial or future capital contribution commitment as a source of repayment of the debt. Members will sometimes be asked by a lender to the limited liability company to sign promissory notes payable to the limited liability company in the amounts of their future contributions.The promissory notes are then assigned as collateral to the lender to secure the loan to the LLC.
Limited liability companies can also raise additional capital by creating and issuing additional membership interests in the LLC to new members. Unless the operating agreement provides otherwise, the consent of all members is required to issue new interests in the limited liability company. Because the issuance of additional interests to new members almost always will dilute the profit shares of the existing members, operating agreements that give the LLC the authority to issue additional interest usually impose conditions, such as requiring a minimum capital contribution for any new member or that any additional interests be offered first to the existing members.
Transferability of Membership Interests
Members of a California LLC cannot sell or assign their ownership interest to another person, and make that person a member, without the consent of all other members, unless all of the members have previously agreed in the Limited Liability Company Operating Agreement. Compliance with state and federal securities laws may be required in connection with sale or transfer of membership rights. If a member desires merely to sell or assign their economic rights to receive distributions, without giving the buyer or assignee any management or voting rights, California law permits the transfer of these economic rights, unless the transfer is prohibited by the LLC operating agreement.
Maintaining Limited Liability Company Good Standing
The life of an LLC is continued when it abides by its own Operating Agreement and complies with the law and regulations.
California LLC Record Keeping Requirements
A California limited liability company must keep in its records a current list of the names and addresses of its members, a certified copy of its Articles of Organization, and all written operating agreements. Every member of the LLC has the legal right to inspect the company’s records.
Tax Treatment Considerations
By default, an LLC is not taxed on its income. Members report income from the LLC on their individual income tax return.
A limited liability company can change this default tax treatment by electing to be taxed as a corporation. Then, the LLC is treated like a corporation and members are treated like shareholders of a corporation.
The principal benefit available by starting a California LLC is its limited liability protection to members. Other benefits include the ability to share profits and losses as the members agree. The pass-through tax treatment is preferable to many business startups.