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Entrepreneurial Trap

Entrepreneurs in California sometimes want to organize their companies in other states, like Delaware or Nevada. They learn that companies can pay less in franchise fees in Nevada, or that Delaware is seen as the state for great corporations. There are good reasons to organize in those states, but for many companies operating in California, it would be a waste of time and money.

Dela-where?

Delaware is well-known as the state of incorporation for most public corporations in the United States. Why? Because the laws of Delaware are quite favorable to the management of public corporations. Also, in part because of this favorable law, Delaware’s Court of Chancery is extremely experienced in business litigation, and juries are not used. For companies with a nationwide presence, incorporating in Delaware is quite advantageous. For smaller companies, there is not much advantage, and the annual franchise taxes, if matters are not structured correctly, can be devastating. A company that once incorporated in Delaware with a great number of authorized shares of stock was shocked to receive an annual bill for more than $1 million – many times their annual revenue for the year.
But We’re Superstars! Yet, you ask, what happens when (never if) we hit it really, really big? We are the new Google/Yahoo/Apple of the 21st century – won’t it be too late to choose Delaware? No. Once you become the superstar you are destined to be, you can reincorporate your business in Delaware. Until then, you can save your cash and your hassle by dealing with just California.
Nevada’s laws are more focused on the smaller entities. Advertisements pushing incorporating in Nevada say that it is cheap and private. While true, the ads do not reveal something else: all corporations and LLCs doing business in the state of California have to register with the California Secretary of State.

Gambling with Nevada

This applies for “foreign”corporations and LLCs – “foreign” here meaning “non-California.” According to California Corporations Code § 191(a) doing business in California “means entering into repeated and successive transactions of its business in this state.” Leasing office space or phone systems, hiring employees, and selling goods or services are considered doing business in the State of California. That means that you have to register as a foreign or domestic corporation or LLC. That means you pay at least the annual California $800 franchise fee, plus you have to file (and possibly pay) taxes here in California, as well as do all the paperwork normally associated with a limited liability entity in California.
The temptation, of course, is to skip on the registration in California – after all, who is going to catch you? The State of California, for one. If you have employees, you will have to make withholdings on their paycheck. You also have to have worker’s compensation. Even if you do not have any employees, you are counting on getting money from the business, and California’s many agencies can crosscheck to see if the business is in good standing.
Moreover, if the business wants to enforce – or defend – its rights in court, it will have to be in good standing to do so. A corporation or LLC that is not in good standing cannot appear in court.

Golden in California

Moreover, any contract signed by the “foreign” corporation or LLC may be voided by the other party to the contract. Someone who wants to void the contract with your business, or who is in a lawsuit with you, can get your business declared to be not of good standing – and you are frozen out of court until your business is back in good standing. Moreover, you are liable for penalties and back payments of the franchise fees. Foreign corporations are liable for $20 per day in which they do unauthorized business in the State of California, plus a $250 penalty.
The lesson – do not assume that what is good for a big company, or what is said in an ad on the radio – is the right solution for your business. Talk things over with an experienced business lawyer to find the right solution for you.

Maps courtesy of Wikipedia Commons:
Delaware: Courtesy of the University of Texas Libraries, The University of Texas at Austin
Nevada: Public domain, courtesy of the Perry-Casteneda Library, University of Texas
California: US Department of Commerce,
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