Today, we launch our new blog with a 10-part series on Ten Mistakes Businesses Make (and How to Avoid Them).
When you choose a business entity for your business – honor it! Regardless of whom you talk to – in-house legal counsel, accounting or marketing – the discussion has to start with a few basic questions:
- Who/what are you – a Corporation, a Limited Liability Company (LLC), a Limited Liability Partnership (LLP), a Sole Proprietorship, a Partnership, or a Close Corporation?
- What do you do?
- How do you do it?
- For whom do you do it?
Most importantly, it is in this analysis that the scope of your personal liability is determined. Are you protected personally from liability for things that may go on in your company?
That is why it is so important to create your entity and do your annual reports, keep track of records for the company, and put assets in the company and treat them separately from your personal assets.
Your business personified
A company is a person, as we now know in the Citizens United case that imparts “person” status on corporations for
purposes of campaign contributions, but corporations have always been people in the eyes of the law.
That means that they have a separate and distinct personality and everything that comes with that “personhood” – a bank account, Tax ID number, a mission, a board of directors or managers for governance, a specialty, etc. The entity’s income is separately earned (and taxed) and invested in the enterprise.
What happens if you don’t honor the entity?
Well, let’s step back. If you establish a company to create a mission and earn profits, you want to draw clear lines of demarcation between your personal assets and your company’s assets. The expression used is that you “create a veil” that protects you from personal liability for activities that occur in the company.
If you do not honor the entity, it is said that the “corporate veil is pierced,” meaning that the protections afforded your company may be punctured through litigation and a determination of liability could be made that would, in fact, reach through the company and get to you personally.
Under what circumstances do you lose the protection of the corporate liability veil?
- Absence or inaccuracy of corporate records and failing to maintain formalities and protocols, i.e., no minutes of meetings, no record that a board met to decide to take a collective action, no annual filings with the Secretary of State’s Office, no tax returns filed.
- Keeping an “Arms’ Length” relationship to people and other related entities that you may be involved in.
- Misrepresentation of members of the organization.
- Intermingling of assets of the corporation and of an individual or group of shareholders. This may be the most common area of difficulty for a small closely held corporation.
- Non-functioning corporate officers and/or directors.
- Treatment by an individual of the assets of corporation as his/her own.
- Using the corporation as a “façade” for dominant shareholder(s)’ personal dealings.
Any one of these seven deadly sins can cause problems for the company and threaten your liability protection. Review your records and get a check up!
Don’t avoid getting legal advice
Despite the seven deadly sins mentioned above, many small business owners do not seek legal counsel for fear of high costs.
- First of all, this could be “penny wise and pound foolish,” since liability exposure could result in a bet-the-company legal situation that could be devastating to your business.
- Secondly, there are alternative fee options that some lawyers now offer to create cost predictability. For example, our firm offers a fixed-fee legal service called My Outside General Counsel that provides small- to mid-sized businesses with all the benefits of having in-house legal counsel without the expense.
This helps to create cost certainty for smaller businesses looking to manage the myriad legal requirements surrounding general corporate, employment and regulatory law.
No matter what you decide, as a business owner you need to have a strategy to assess and minimize your company’s overall legal risk by:
- Ensuring business structure and founder’s agreements are air tight
- Performing a corporate compliance check
- Reviewing employment procedures to ensure compliance with all applicable regulations
- Reviewing contracts, agreements, and leases
- Providing real-time access to a team of lawyers, paralegals, and research assistants to help manage legal requirements and achieve your business goals
So, business lesson #1 is to honor the entity and reduce your business liability.
Stay tuned for our next blog post in our series, “Ten Mistakes Businesses Make (and How to Avoid Them),” which will focus on “Protecting Your Assets.”