Doing Business in California
When startups are considering states in which to organize their businesses, Delaware often enters the conversation. Delaware tends to be a favorite for many of our California founder clients. It has taken on a mythic quality for startups – “Delaware, the promised land.” This is likely perpetuated by seeing well-known companies, particularly those that are publicly traded, organize in Delaware. For corporations, Delaware’s laws tend to favor majority shareholders and offer flexibility with respect to fiduciary duties, among other benefits. For example, the corporation can do away with cumulative voting—a helpful mechanism to protect minority shareholders—if it so chooses.
A corporation/LLC is domestic in its organizational state and, as a result, foreign to all others. Being a foreign entity doing business in California can have several implications, and the definition of doing business can vary depending on the context. The phrase “doing business in” has different meanings for the purpose of determining whether the business is subject to California taxes or to California regulations (both for internal governance and external activities), or whether it must register as a foreign entity in California.
Registration as Foreign Entity
For example, whether a foreign entity must register with the Secretary of State in California largely depends on whether it transacts business in California. The definition of “transact business” can be found in many places throughout the Corporations Code, depending on whether the business is an LLC, corporation, partnership, etc., but the common thread among them is that the company must enter into repeated and successive transactions of business other than interstate or foreign commerce. There’s a laundry list of what does not fall into this category, including simply being the parent company of a California entity, maintaining bank accounts, or effecting sales through independent contractors. For the full list, see California Corporations Codes §§ 191(a), 17708.03(a), 15901.02(ai)(1), and 16959(l).
On the other hand, Section 23101 of the California Revenue and Taxation Code has a much more liberal definition of “doing business” in California, which is defined as actively engaging in any transaction for the purpose of financial or pecuniary gain or profit. For additional information on doing business for the purpose of taxation in California, see the CA Rev. & Tax. Code. To determine what taxes, if any, a foreign entity must pay in California, speak with your tax attorney or CPA.
With respect to LLCs, there’s a rebuttable presumption that any LLC that has members or managers in California is doing business in California and must register to do business here and pay the annual tax and fee. The business can overcome the presumption by showing that the member is purely a passive owner.
Lastly, there’s the matter with pseudo-foreign corporations, or corporations that are primarily owned and operated in California even though they’re organized in other states. In these cases, California Corporations Code Section 2115 applies certain shareholder and creditor protective provisions to the foreign corporation, including the right to cumulative voting. See the specific language of the statute for rules that apply to corporations falling under its purview.
No Panaceas Here
Most California founders looking to other states are doing so because they want to avoid California. But California, like many states, is that opportunist frenemy who can see your potential and wants to ride your coattails as far as it can, using any good deeds it’s done for you to force your loyalty. You want to live here, have any property here, or reap any benefit from California’s existence as a state? Great, we’d love to have you…but prepare to pay up. If there’s a finding that you are “doing business” in California, then you’ll find yourself in California’s jurisdiction.
A fact-specific and nuanced analysis should be conducted, usually with the help of an attorney, to find out if a particular business is doing business in California under each relevant circumstance.