Paperwork can be a pain. You never want to let it distract you from running your business, but crossing the proverbial “T’s” and dotting those “I’s” is very important. The reason is that your business entity protects you. It shields your personal assets from any liabilities that may be incurred by your business entity, whether that entity is a corporation, a limited liability company, or a limited partnership.
Business owners can take some very specific actions to make sure that their personal and corporate assets are separate. A few of those actions are outlined in more detail below.
The Corporate Shield
At the very minimum, well-functioning businesses should take full advantage of the protection of a business entity. Corporations, limited liability companies, and limited partnerships are examples of business entities. When choosing a business entity and developing operating procedures for that entity, one risk business owners should consider is that a court might one day be asked to “pierce the corporate veil.” If a court pierces the corporate veil, then shareholders, members, or partners (as the case may be) could be individually liable for the obligations of the business entity.
To fully understand this concept, we must understand corporate liabilities, which are also termed “inside liabilities.” Inside liabilities are obligations directly incurred by a business entity without a personal guarantee by the business owner. In theory, only the business entity should be responsible for inside liabilities.
Corporate Laws That Protect You
In theory, business entities act as corporate shields. The corporate shield is intended to protect business owners—shareholders, members of an LLC, and limited partners—from being responsible for a business entity’s inside liabilities. In other words, only assets owned by a business should be available to satisfy judgments against that business.
One simple solution might be to limit the number of assets owned by a business. Cab companies have been doing that for years, but while the idea sounds right intuitively, undercapitalization is one factor that courts consider when deciding whether or not to pierce the corporate veil. If a court does decide to pierce the corporate veil, then the individual assets of a business owner can be used to satisfy a judgment. That’s not a good result, and it’s worth a little upfront and ongoing paperwork to avoid.
There are a few actions you can take to drastically reduce the chances that your corporate shield will ever be disregarded.
- Make sure that your business entity is formed correctly. This includes being appropriately qualified as a “foreign business” if your business entity was formed in a state different from the state where it primarily operates.
- Good record-keeping is a must. Use your business name (and not your name) when conducting business, entering contracts, paying bills, and when marketing.
- Have separate accounts. Maintain separate credit card and bank accounts that are used for only business expenses. Be meticulous! Treat your business entity as though it is an autonomous person rather than as an alter-ego of yourself.
- Title business assets in the name of the business. This should go without saying, given everything else we’ve discussed.
Carry Insurance
It’s also a good idea for owners to consider and buy appropriate insurance coverage. To know what coverage you need requires studying the risks involved in individual business enterprises and conducting a cost-benefit analysis. Insurance available to businesses includes policies such as general liability, professional liability (like malpractice, errors and omissions, and officer and director), workers compensation, and property damage.
Insurance is important because it can help “pad” any losses that might result from a lawsuit. An attorney can help you decide what you might need in the area of insurance.
Conclusion
Maintaining your corporate shield is important enough of an issue that business owners would be wise to create a checklist of procedures and conduct occasional quality control checks, just to ensure that proper systems are in place.
The Parents Estate Planning Law Firm, PC
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