August 28th, 2013
By Courtney G. Forster
How your corporate entity can protect you – and how you can protect it
Clients regularly approach me wanting to create a liability shield to protect themselves from personal liability. Most people hear that the best way to protect against personal liability is by forming a corporate entity, but few understand how to go about creating this liability shield or how to use it.
The idea behind a liability shield is that a corporate entity will help protect you from being sued personally when something goes wrong. When used correctly, these entities are a great tool to help you launch a business without risking your personal assets. Unfortunately, all too often small business owners will inadvertently harm or destroy their liability shield through sloppy paperwork, financial errors, and inaccurate bookkeeping. Here are some key tips to keep in mind when forming and operating a corporate entity so you can ensure your corporate liability shield remains strong and intact.
1. Get your paperwork in order.
The first step to forming a corporate entity is creating the necessary paperwork. If you are forming a limited liability company, this will include an operating agreement; if it’s a corporation, it will include articles of incorporation and issuing stock. Either way, you will also need to register the company with the secretary of state. If your company needs a business license or any operating permits or licenses, be sure to obtain those in your company’s name as well. Make sure you have these in place before you do anything else with your company or you could end up liable for events that took place before your paperwork was finalized.
For a relatively low fee, an attorney can help make sure you’ve set up your company correctly and have all the necessary forms. Internet-based companies that offer to set up your company for you often charge the same – or more – as a local attorney and will give you one-size-fits-all paperwork that may not be right for you. You will also need to maintain these records on a yearly basis, including keeping company minutes and renewing your filings with the state. Again, an attorney can help make sure your paperwork stays current and you don’t end up with a gap in your protection.
2. Hold the asset or assets in the company.
Once your company has been formed, make sure you use it! A company is only as good as what’s in it, so make sure you keep the asset or assets in question in the company’s name. For example, if you are planning on renting an office building to tenants, make sure the office building is owned by your company (rather than you individually). However, always keep your personal assets out of the company – this is for business only.
3. Don’t commingle money.
The biggest, and most common, mistake people make is mixing their company’s income or expenses with their own personal income and expenses. You could be out at dinner and forgot your personal credit card, so you charge the meal to your company card. Or maybe you use the company card to fill up your gas tank from time to time – it’s okay because you sometimes run errands for the company, right? Unfortunately, these are classic examples of using the company’s assets for your own purposes. This is the fastest way to destroy your corporate shield and expose yourself to personal liability. Always, always, always keep your personal finances and your company finances separate.
If you have more than one company, the same lesson applies to them – the more you combine finances between the two companies, the greater risk you run of having a court treat the two companies as one entity. Especially in smaller or one-asset companies, the money is usually where the most action is: if your financial records show that you treated the company like your personal bank account, the courts are going to ignore the corporate liability shield.
4. Adequately fund the company.
This rule is basic, but vital: keep enough money in your company for it to operate. If you remove income from the company and leave it unable to pay its debts, the courts may ignore the corporate form. When you start your company, make sure it has enough assets or money to operate, and keep enough funds in its accounts to pay its debts. Don’t forget to also maintain sufficient insurance in the company’s name. Again, this will show the courts that the company is able to operate as its own independent entity and is not simply an empty shell.
5. Maintain accurate, up-to-date financial records.
Careful and thorough bookkeeping will reinforce the idea that your company is its own separate entity. If you borrow money from one company to fund another, make sure that loan is properly tracked, accounted for – and eventually repaid. Don’t forget to file tax returns for each company as appropriate. Again, courts will always look at the way your finances are when evaluating whether your company will protect you as a liability shield.
6. Notify business partners they are dealing with a company.
Another simple, but critical, point to remember is to always notify your business associates that they are dealing with your company rather than you personally. Always use your company’s name on all contracts, invoices, and the like.
7. Remember: a corporate liability shield can only do so much.
Even with the strongest corporate liability shield, no system is airtight. Many banks will require you to sign a personal guarantee when your company borrows money – if your company later defaults on that loan, you will be personally liable for any amounts covered by that personal guarantee. A corporate shield also won’t protect you if you commit fraud or other bad acts in the company’s name. However, if you stick with these basic rules and are careful about maintaining your company’s separate status, you can protect your company while it protects you.
Courtney Forster is an Associate at Gunderson Law Firm. She earned her Juris Doctorate from Notre Dame Law School, and can be contacted directly at email@example.com or 775-829-1222.