One of the primary benefits of incorporating your business is ensuring that you (and any other co-owners of your business) aren’t held personally liable for the legal and financial obligations of the business.
The business entity limits your liability by creating a corporate veil between your personal assets and the liabilities of the company, meaning that your personal assets can’t be used to satisfy the debts of the company. If your business takes a down turn, experiences financial difficulty, or becomes insolvent for any reason, your business entity is there to make sure your creditors aren’t allowed to put a lien on your house or other personal assets in an effort to make themselves whole.
However, if the business entity isn’t properly maintained by observing certain corporate formalities and engaging in best practices for corporate compliance, then it won’t be able to provide you with protection when you need it. When this happens, creditors can “pierce” the corporate veil and come after you personally to satisfy your company’s obligations.
Think of it this way – if you have a wooden fence around your backyard, it won’t provide the protection and privacy you’re looking for if you don’t take care of it and let it rot or fall into disrepair. The law requires each of us to take personal responsibility to protect and manage the things we own, including our businesses. It is there to help you, provided you also help yourself.
When it comes to your business entity, just like a fence, you have to build it properly and then maintain it over time so it continues to serve its purpose. Below are five things you can do right now to be sure you’re maintaining your business entity.
1. Keep good business records and observe necessary formalities.
Be sure you document all major business decisions and put them in your corporate book. For example:
- Sign and keep copies of the contracts your company enters (internally among owners and employees and externally with vendors and suppliers).
- Review and update your operating agreement (LLCs) or bylaws (corporations).
- Create and maintain a membership (LLCs) or stock (corporations) transfer ledger so you always know who owns what portion of the company.
- Hold annual meetings of your members/managers (LLCs) or directors and shareholders (corporations) and keep copies of the minutes.
2. Don’t co-mingle your business assets and personal assets.
This is a huge “no-no.” The entire purpose of a business entity is to create something separate and distinct from yourself, so be sure you treat it that way.
You should have separate bank accounts (even if you’re a sole proprietor) for your personal funds and business funds and maintain separate credit cards. Keep your business property and equipment separate from your personal property and equipment, too.
3. Do business in your company’s name, not your own.
Always enter into agreements – big ones and small ones – in the name of your business, not in your own name.
Try to avoid signing a personal guarantee for the obligations of your business wherever possible. Equipment leasing companies (e.g. companies that lease copiers and postal meters for your office) are notorious for asking business owners to personally guarantee the leases. Be sure to read the fine print before you sign on the dotted line.
4. File all of the required documents to keep your company in good standing.
Each state sets its own requirements for corporate compliance. Most states require some type of annual filing, often called an Annual Report or Annual Statement. Failure to file those on time can result in penalties and liens on your business.
You want to be sure you file the proper reports in your home state and in each state where you’re qualified and registered to do business. You need to qualify to do business in each state where you run and operate your business, not each state where you have customers. For example, if you are headquartered in Pennsylvania but have a satellite office in Virginia, then you need to be registered in Virginia as well. The same goes for fulfillment centers, training facilities, and so forth.
5. Pay state taxes and renew business licenses
Some states impose a franchise tax on business for the privilege of doing business in that state. Be sure you stay on top of those requirements and plan for them in advance. You don’t want to miss a deadline or fail to budget for your taxes.
The same goes for payroll and unemployment taxes. These can be a killer for small businesses. The fastest way to get yourself in trouble is to fail to pay payroll taxes on time.
Additionally, some types of businesses and occupations require special business licenses, such as health and medical-related business, that must be renewed each year. Here also, you don’t want to fail to renew your licenses and risk having your business fall out of good standing which could compromise your ability to do business.
Each state has its own unique requirements, so you want to be sure you educate yourself on them and touch base with your business attorney on at least an annual basis to confirm you’re taking care of the required formalities. Protecting your corporate veil isn’t hard. It just takes some time and attention — something many small business owners have little of for things that aren’t directly tied to sales and revenue.
Remember, just like your fence, if you don’t take care of it, it won’t protect you when you need it to.