Forming a business is only the first step in ensuring that your personal assets are kept separate from you business interests. - This is important because if you do not keep these separate there can be dire consequences- if something happens in your business to create a liability issue your personal assets may end up being up for grabs as well. Following the guidelines below will help to create and maintain your business as a separate entity- protecting your family and home from any business liability.
First, it is extremely important to understand why Corporations, Limited Liability Companies (LLCs), and Limited Partnerships (LPs) are used to conduct business. These entities are legally created and regulated by state laws and thus are legally separate from the individuals who own them. To retain this separation between the owners and the entity, certain legal requirements and formalities regarding the maintenance and operation of the entity must be followed. If these requirements are not met, the separation between the owners and the entity may be disregarded—sometimes with disastrous consequences.
WHAT’S AT STAKE?
If certain legal formalities and requirements are not met, your Corporation, LLC, or LP could be disregarded as an entity separate from its owners or managers and as a result your personal assets may be at risk for your business liability. The following is a brief summary of some of the consequences that may result:
- Loss of Limited Liability: If you were to ask a randomly selected group of small business owners why they elected to do business using one of the above legal entities instead of operating as a sole proprietor or general partnership, the answer you are most likely to hear is that they want to protect their personal assets from the liabilities of the business. This is the number one reason business owners incorporate or organize an LLC or LP.
If you do not treat your business entity as separate from yourself, it is possible that the business entity will be disregarded at some time in the future by a court or government agency like the Internal Revenue Service. The result could be financially devastating. If the business entity could not pay its debts, whether from regular operations or from liability attaching as a result of lawsuit or government action, the personal assets of the owners would be made available to the creditors of the business entity.
- Continual / Perpetual Existence: Because business entities are legally separate from their owners, the death or disability of the owner does not mean that the business is dissolved (in the case of death) or unable to conduct business (in the case of disability). Changes is ownership and management are specifically addressed in the by-laws of corporations, in the operating agreements of LLCs, and in the partnership agreements of LPs.
- Access to Capital: A business entity is a more attractive vehicle for investors than a sole proprietorship. Private investors are able to invest in business entities with confidence. This confidence comes from being able to invest and receive either a debt obligation (which may be convertible into equity under certain circumstances) or a portion of the ownership of the entity.
- Potential Tax Benefits: The owners of corporations and LLCs taxed as corporations may be able to receive tax benefits by sheltering business income in the entity—thus reducing the owners’ overall tax liability.
- Commercial Credibility: American consumers are more accustomed to purchasing goods and services from businesses than sole proprietors. This instant reputability is another leading reason individuals use a legally separate entity as the business vehicle of choice.
- Employee Benefits: Under certain circumstances, the ability to offer more comprehensive and deductible fringe benefits may result from the use of a business entity.
All too often, the requirements of just keeping a small business running leave little time for the owner or owners to engage in corporate/LLC/LP “housekeeping” and “maintenance.” Without some level of diligence on the part of the owners, a gradual merger of the life of the business and the life of one or more of the owners or managers may begin. When this happens, the separate legal status of the business entity begins to fade.
WHAT YOU NEED TO DO TO PROTECT YOURSELF AND YOUR BUSINESS
The following steps should be taken by all business entities, even those owned and managed by only one person.
Compliance with the Secretary of State:
As an initial matter, you should ensure that your business entity is in good standing at all times with the Colorado Secretary of State. You will receive an annual report from the Colorado Secretary of State each year (for entities other than Limited Partnerships). It is important that you complete and return this annual report with the required fee. Even if your entity is delinquent in annual filings or other matters, it is usually very easy to bring your entity into compliance with the Secretary of State. Typically, this will involve the filing of a delinquent annual statement or, possibly, reinstating your entity if it has been deemed dormant or inactive.
Internal Governance in Compliance with State Law:
It is important to keep your internal entity governance up to date. This step can not be over emphasized in its importance. Being in good standing with the Secretary of State is only the initial step in having your business entity recognized as separate from you (as the owner) at some future time whether in court or by a government agency.
The most important action item is to ensure that your business document binder remains up to date. (This binder is universally referred to as the “Corporate Book” irrespective of whether you own a corporation, LLC or LP.) The binder should contain your entity’s organizing documents (articles of incorporation or articles of organization), the operating documents (by-laws, operating agreement, or partnership agreement), evidence of ownership (signed stock certificates, membership certificates, or partnership certificates), transfer ledgers, resolutions and agreements to extraordinary actions (opening bank accounts, signing a lease, making tax decisions, appointing officers, etc.), minutes of each annual meeting (discussed further below), tax documents (such as the Request for Employer Identification Number on Form SS-4 [the tax identification number for domestic business entities], S-Corporation Election on Form 2553, Tax Returns on the applicable forms [1065, 1120, 1120-S, etc.]), required permits and licenses for your type of business, leases, loan documents, and any other documentation that is evidence of your respect for the separation of the business entity from yourself.
Reviewing the actions of the entity and planning for any upcoming changes on an annual basis is important. The documentation of this annual review/meeting in the Corporate Book is one of the first items a future judge will review if ever asked to disregard your entity.
You should also make sure the following tasks are accomplished and used in the daily running of your company:
- Open a bank account (usually a checking account) in the name of your entity.
- Ensure that you can document all moneys put into your entity in return for your ownership.
- In any interactions your entity has with other commercial enterprises or individuals, make certain that it is clear that you are acting on behalf of your entity and not as an individual.
- Use letterhead on all of your correspondence and contracts.
- Include the entity designation (“Inc.,” “Limited,” “Ltd.,” “LLC”) whenever possible on business identifiers such as business cards, advertisements, etc.
- Always sign documents in your representative capacity, and not as an individual:
YOUR ENTITY NAME
by: YOUR NAME, YOUR TITLE (Manger, President, Owner, etc.)
- Ensure that all assets that are meant to be owned by your company are titled in the name of your entity and not in your name personally.
- Never commingle the funds or assets of your entity with your personal funds and assets. If you need to fund the operations of your company with your personal assets, document the transfer as either a loan or a contribution to the capital of your entity. If you need to use assets of the company for personal reasons, distribute the assets out of the company to yourself first as income, profit distributions, or a return of your capital contribution.
If you have any legal questions about how to conduct your business, please do not hesitate to contact Tanya R. Shimer LLC for guidance.