In Part 1 of this entry, I discussed problems that some of my Silicon Valley clients have had with improper choice of entity - either because the tax consequences weren't considered, or because restrictions in the California Corporations Code or Business and Professions Code were not taken into account. Here are two more expensive mistakes that business owners make when they try to form their own corporation or LLC online.
1. Not doing the required securities filings.
Online sites may not tell you that if you fail to file California and/or Federal securities filings you could be in violation of securities laws resulting in tremendous personal liability to return funds to your investors, despite the liability shield the entity is supposed to provide. Sometimes by the time I get involved it is too late to fix this, but sometimes we can do a late filing and get some, if not all, of the protection it provides. Corporations, as well as some LLCs and partnerships, are securities and must be treated accordingly.
2. Not completing the formation - with disastrous liability consequences.
By far the most common mistake when forming an entity yourself is not having the expertise to know what needs to be done after the initial filing with the Secretary of State, or not hiring the right advisor to counsel you. I have worked with many Silicon Valley business owners who thought they had a liability shield in place because they created their corporation or LLC with the Secretary of State, but in fact they were not in compliance with the Corporations Code and therefore did not have a valid entity to protect them in case they got sued. Filing Articles of Incorporation with the Secretary of State and getting an employer identification number with the IRS is not sufficient to create an entity. LLCs must have operating agreements. Corporations must have bylaws as well as minutes documenting required annual Board of Directors and shareholder meetings, electing directors, appointing officers, and approving corporation actions.
If you are not sure if your business is in the right type of entity, and is properly formed, don't wait until it is too late. Get advice now, before it negatively impacts your business later.