How to Form a Business [Part 1]

With the economy in such bad shape, many unemployed people have chosen to ditch the job search entirely and open their own business. This is especially true for people forming web-based businesses, which are more popular than ever.

Personally, I think this is a great idea. What better way to beat an unbeatable economy than by forming your own business? If you work hard and have a little luck, you could find great success – or at least keep yourself busy until the economy turns around and you can get another job.  I also find small business owners to be the most interesting, most creative, and most innovative types of people.  They’re the kinds you want to talk to at a cocktail party. Except that most small business owners are too busy running their businesses to go to a cocktail party.

I’m not going to tell you how to make your business successful, because there are an infinite number of types of businesses you may launch, and there’s an infinite number of ways to make that business successful. There is also a wealth of free information on the web about the nuts and bolts of launching the business itself (here is a great blog posting on How to Start a Business With No Money).  However, I did want to create a comprehensive, step-by-step guide which covers the legal aspects of starting your own business.

Determine the Right Business Form

The first step is to determine what is the right business form for you.  For a number of reasons which will become evident a little further down, I generally advise clients that a Limited Liability Company (LLCs) is the best entity for a new startup business if your chosen field is eligible.

How Do I Know if I am Eligible to Form a LLC?

You cannot render professional services such as legal advice or accounting advice through a LLC. Generally, “professional services” includes any service may only be lawfully rendered if you have a license, certification, or registration.  This includes, in addition to lawyer or accountant, a doctor, chiropractor, architect, etc.

If you are planning on launching a business to provide services in one of these fields and you have the appropriate licensing, then you may need to form a professional corporation.

How to Form a LLC

From here on, I describe the specific steps you need to take in order to form an LLC.  The main reasons I recommend forming an LLC is LLCs are very easy and inexpensive to set up, very flexible, and have limited administrative or procedural requirements.  Owners and investors in an LLC can also shield their personal assets so that they are not liable for the debts of the LLC beyond their financial investment.

Unlike a corporation, an LLC does not issue stock and there are no formal requirements to hold annual meetings or keep written minutes, which a corporation must do in order to protect its owners from liability.

Should I Form a Delaware LLC or Corporation?

A common misconception is that you should form a Delaware-based corporation if you are starting up a business. While there are advantages to using a Delaware corporation, for most small businesses these advantages are outweighed by the burdens and the fact that forming a Delaware corporation is completely unnecessary.

Delaware has become known as a favorable place to incorporate because their corporate laws are very favorable to corporations, and consequently the state has a very sophisticated corporate environment. You know how there’s a saying (perhaps an urban legend) that Eskimos have multiple words for snow? Well, Delaware has a lot of words for corporations, and for every matter affecting corporations.

If you incorporate in Delaware, you need to follow Delaware corporate law in managing your corporation, you may need to hire an attorney versed in Delaware law if you are sued there, and you need to pay a local company or individual to be your registered agent for service of process.

If you are only planning a modest small business and not planning on doing business in all 50 states, then forming a Delaware corporation is largely unnecessary. In addition, you can always convert your company from a LLC to a Delaware corporation later if necessary.

Check For Name Availability

Assuming you have decided to form a California LLC, then the next step is to check and see if your preferred name is available. I suggest you start by brainstorming a number of names.

You can fill out an official form with the California Secretary of State’s office to check on the availability of a name, but there’s also a short cut. Go to the Secretary of State’s Business Search page and search for names. Be sure to check for all three types of names: corporation, LLCs, and Limited Partnerships.

The California Secretary of State’s website does not check names against trademark or service mark registrations or against fictitious business names, so you will also want to check the USPTO website for registered trademarks, using the Trademark Electronic Search System (“TESS”).

To check fictitious business name registrations, you need to check with your local county.

Once you have found a unique name which isn’t already in use for a LLC or corporation and hasn’t been trademarked, then you are ready to form your LLC.

You may also want to file a trademark application to protect your intellectual property and the good will you will invest in your new business name. If you want to trademark your business name, you can read about how to do so here.

In Part 2 of this series, we will discuss how to draft the Operating Agreement, file the Articles of Organization, apply for a federal taxpayer identification number, and separate your personal assets from your business assets.

Of course, feel free to add any comments or questions in the comments below!