Starting a company is not as easy as people think. The first step is determining what type of entity the business is to be structured as. Partnership, limited liability company (LLC), s-corporation, c-corporation or sole proprietorship are the typical choices, but there are other less used types. The choice of entity has great effect on the owners and/or investors taxes as well as liability. Before going any further let me say this is not written by an attorney or accountant and professional advice should always be sought when starting an entity. The choices made in the beginning will affect the start, growth, and exit of the investment so it is important to tie up loose ends and stay on course as the business grows.
Liability is a word many people have heard but few fully understand. To be liable for a business essentially means accepting responsibility for damages caused by the actions of the business, its partners, or its employees while acting in the scope of their employment. This is a lot of responsibility because as businesses grows so does the exposure to potential liability. Business owners seek to limit their exposure in order to protect themselves and limit their personal liability. Personal liability means that the owner can be sued for the actions of the company not only as an owner, but as an individual. In short this means all of an owner’s personal belongings are on the line if an incident were to occur. Personal liability is often too great a risk for an individual to take, so it is important to talk with an attorney about the proper structure in order to limit the liability.
The first step to starting a company is filing the paperwork. Let’s use an LLC as an example because it is the most popular due to the flexibility. LLC’s require individuals to file Articles of Organization with the Secretary of State in South Carolina (Check with the state where the entity is to be domiciled for proper procedure). This allows the state to know that an entity has been set up and registers that entity with the government. Unfortunately, many businesses stop there and believe they have done everything required to start an LLC and limit their liability. In order to properly create the LLC, after the LLC is registered the business needs an operating agreement which dictates the terms of how the business will handle important events such as formation, tax matters, voting, and most importantly dissolution. Dissolution is not an easy subject to discuss when a business begins because everyone involved cannot fathom the idea of the business failing or partners splitting, but discussing the issue in the beginning is much easier than discussing it later.
Attorneys play a critical role in crafting the documents in order to fairly blend the intentions of the owners with the state’s law where the entity is domiciled. The law varies in every state and the legislators’ intent of how to operate companies may not be the same as the business’ partners’ intentions. The operating agreement allows the partners to form their own rules for governing their entity, and helps solidify the corporate veil between themselves and the company.
The corporate veil is the idea of a legal curtain separating the actions of the owners and their business. The basic concept is the actions of the individual person are separate from the business and vice versa so neither should be held liable for the actions or inactions of the other. The concept may seem foreign, but if liability is incurred the only thing separating the business and the individual is this corporate veil. Unfortunately, creating the corporate veil is the easy part as attorneys and the proper paperwork can accomplish that task, but maintaining the corporate veil can be far more difficult.
Most small businesses are owned and operated by the same individuals. The company credit cards, gas cards, check book and bank accounts are all in the possession of the owner(s). This creates a situation that makes blending the cash very easy. For instance a business owner may forget to deposit money in their checking account so they purchase a family dinner using the company credit card. This act makes differentiating between the individual and the business a little less clear. If liability arises and the court sees enough evidence that the actions of the individual and the corporation have not been maintained separately then it can rule the individual and the business are in fact one in the same and should be treated as such for liability purposes. This act by the courts refers to piercing the corporate veil which means that despite all of the proper paperwork the individual and the business are the same and therefore the individual should be liable for the actions or inactions of the business. Piercing the corporate veil means all of the owners’ personal property is back on the line in litigation.
Starting a business presents many challenges most of which center around financing and generating revenue from the product or service the business is looking to provide. These challenges make it very easy to overlook the need for spending additional money on attorney’s fees and filing fees; however, overlooking the need for professional help can cause serious consequences down the road. The goal of every business owner is to create a business which is going to not only grow but thrive. Thriving businesses have a lot of moving parts and create a much larger exposure to potential liability. Business owners should consult an attorney at the very beginning and work to develop a relationship with that attorney so that as the life of the business progresses the attorney can consult with the owners and guide them through the issues as they arise.