Forming Your Own Corporation or LLC Online May Cost a Lot More Than Using a Lawyer, Part 1

I was in Los Gatos getting my hair cut this weekend and my hairdresser said something very interesting – he said that his best clients are the ones who try to do their hair themselves (especially their color) and then come to him to fix the mess they made. He said they are so grateful when he fixes the problem they created that they become clients for life. I am not the type of person to try to do my hair myself – too much risk for me. However, it struck a chord with me because it seems more and more I spend my time working with clients who have formed their own corporation or limited liability company through forms found on the internet, and then come to me to fix some problem they caused.

What is wrong with forming your own corporation or LLC online? Nothing, if you know what you are doing. However, most people who are starting a new business and need an entity do not specialize in forming companies. Here are two of the four most common (and costly) mistakes I have helped my Silicon Valley clients fix:

1. Picking the wrong type of entity — with disastrous tax consequences.

In California, there are very different tax consequences for C corporations, S corporations, partnerships and limited liability companies. When I choose what type of entity to form for a client’s new business, I consider franchise taxes amongst income and other taxes. For a real estate entity, I also consider property taxes and transfer taxes which can be quite different in Santa Clara county or another county. Fixing the type of entity can be as simple as making a tax election, or as complicated as converting to another form of entity – which can be done, but it is a lot more expensive than starting out with the right entity in the first place.

2. Forming an LLC for a business that is not allowed to be an LLC.

The California Corporations Code prohibits certain businesses from being a limited liability company. For instance, if your business is required to be licensed or certified under the Business and Professions Code, it is not eligible to be an LLC. I hate to see business owners spend their time and money on filing a limited liability company online, only to find out much later that it was not only worthless, it was giving them a false sense of security because they had no liability protection. The only fix here is starting over or converting to a corporation or partnership – both of which require new bank accounts, business cards, letterhead, etc. and are time consuming and expensive.

See Part 2 for two more expensive errors.