Most people have heard of an S-Corporation or an S-Corp, but not many people really know what it really is and more importantly, what it isn’t.

I get asked a lot by potential clients, if I can form an S-Corp for them. I have to inform them that you do not form an S-Corp, you elect it.

To be more specific, when you create a corporation under California law, the letter S never comes into play. You have to look at this at two levels. First is the entity creation at the state level. California code regulates entity formation in our state. So if a corporate form of entity is what you want (as opposed to limited liability companies, partnerships, etc.) you form a regular corporation or a statutory close corporation (if your company qualifies).

Once the corporation is formed, you or your incorporator will then file for a Federal Employer Identification Number, or EIN/FEIN.  You will tell the IRS what form your business is, and then whether you will elect to tax your corporation under Subchapter S of the IRS code, as opposed to Subchapter  C (which is why you will hear the term C-Corp). Subchapter S of course being the pass through treatment whereas income is taxed at the corporate level but no taxes are paid, the income “passes through” to the owners and tax is paid at the shareholder level. Thus, S-Corps are treated almost like partnerships, with some differences.

This was created because many small businesses are owned by very little people, making the formal C-corp treatment very tedious, as well as wanting to see the inherent double taxation of C-Corps eliminated for small businesses.

I came across an nice online book titled TEN FATAL MISTAKES BUSINESS OWNERS MAKE (AND HOW TO AVOID THEM), put out by Gibson Ferrin & Riggs, PLC.  All small business owners should read it.

Mistake #4 was failure to use a qualified statutory agent.  In California we generally call these agents, “Registered Agent For Service of Process.”  To put that in English, when you form a legal entity, such as a corporation or a limited liability company (LLC), you need to designate an agent that, when faced with a lawsuit, will receive service of process by the people suing you.

Failure to use a trustworthy agent can lead to problems, such as failing to respond in a timely manner, or outright concealment by the agent.   If you currently have a small business attorney you work with, you may ask if they provide this service (sometimes at no charge to you).  You will also see CPA’s, accountants and other service providers act as agent for their clients.  Personally I suggest using your attorney or a dedicated company that provides such services.

While I do not endorse these companies specifically, a few companies I have seen mentioned as big players in the market are:

1. National Registered Agents, Inc.
2. Corporation Trust Company
3. Corporation Service Company

Those are the big 3, and with any service provider, perform your due diligence before hiring anyone.

 Last night a tremor hit Southern California. It registered a 4.7 on the Richter scale, was centered in Los Angeles and was felt here in San Diego by your very own.  Fortunately the quake originated over 8 miles deep in the earth and initial reports show no significant damage or injuries.

However, the earthquake brings up a crucial question: Does your small business have a disaster recovery plan or a business continuity plan?  Business continuity planning is the more general planning involved when a significant disruption occurs and includes plans for personnel, facilities, communications (between personnel and customers) and other issues.

Disaster recovery planning focuses on IT infrastructure, data, hardware and communications.  If an earthquake hits, would you be able to resume business elsewhere?  How long would it take to retrieve business data?  Can you even retrieve it? Earthquakes are not the only concern. Fires, energy blackouts, flu pandemics all factor in to such planning. Your facilities may not even be destroyed but something may prevent you from accessing your physical buildings.  A power surge may blow up your server with critical applications and data stored on that server.

DRP should involve at a minimum backups of all applications and date off-site, and the ability to restore them should anything happen to the server or access to the server is limited.  Storing this data in a different region is even better to safeguard against local disasters (think hurricane, total blackouts, etc.).

A DRP should take into account any regulations that cover your business.  Many businesses these days are regulated by a regulator/agency somewhere, and they may have rules in place requiring a minimum level of recovery planning.  Even if your business is not regulated by a specific agency, there may be state requirements that, while not explicitly requiring a plan, make it prudent for your business to have some sort of DRP in place to satisfy other requirements.

Planning for disasters and other disruptions will require collaboration between the business owners, the IT department/person and someone knowledgeable in related regulations to develop an effective plan.

One of the features touted when discussing incorporation or organization of a limited liability company (LLC) is limited liability.  In other words, by forming a corporation or LLC (or other limited liability entity) you shield your personal assets from most business liabilities.  There are instances where your entity will not shield you from business liabilities but we'll cover that another time.  Today we're discussing personal guarantees which normally arise during the formation process or shortly thereafter.

As a newly formed entity there is no credit history for your entity.  Remember back to when you were 18. No matter where you were, credit card companies found you. And they offered you credit.  But not much.  My first card had a $500 limit.  Why was my limit so low?  I didn't have bad credit, but I had no credit.  My credit history was too short.  Maybe if my parents co-signed I would have gotten a higher limit.  The same risks are associated with a new company.  With no credit history, the lender has no way of knowing the risk profile of the new business.  There may be no recourse if the entity should go belly up.  It also opens up the possibility of fraud in some cases, if no individual will offer up a personal guaranty.

A personal guaranty is essentially what it sounds like, a guaranty from the person soliciting the loan/credit/contract on behalf of the entity.  This usually includes residential leases, loans and some other business related contracts.  Whoever agrees to the guaranty is putting up all of their personal assets in order to complete the deal.  This may sound like it defeats the purpose of the entity, but it should not be viewed as that way.  When you start a business in earnest you're not assuming it will fail anytime soon.  If everything goes as planned you will have a successful business and when you have established enough business credit, you may seek to lift your personal guaranty and rely solely on the credit of the entity.

This is quite common among small businesses when first beginning operations so don't be alarmed, but be aware of what a personal guaranty entails.

Download our FREE REPORT "The Top 10 Mistakes That Can Destroy Your New Small Business" to learn about this and other mistakes to watch out for.