While some business owners often forego the formation of a legal business entity (corporation, limited-liability company, etc.) to protect personal assets from the liabilities of the business, the business owners that actually do so often fail to follow several simple business practices to promote that legal protection.
That failure can prove to be fatal when a business entity has insufficient assets or has filed for bankruptcy, for a plaintiff or judgment creditor will then look to the business owner's assets in what is commonly referred to as "piercing the corporate veil." While courts will evaluate the facts and circumstances surrounding the business entity and its relationship with the business owner, the following business practices will go a long way to avoiding the risk to personal assets: Adequate capitalization: A common problem that occurs with businesses, particularly small businesses, is undercapitalization.
When a business is undercapitalized, there is a perception that perhaps the business entity was never established as a separate legal entity from its owner.
Thus, the business owner should properly evaluate what the business needs are to be adequately capitalized.
Avoid co-mingling funds: Oftentimes, a business owner will co-mingle his or her personal funds with the funds of the business.
By doing so, the business owner gives the appearance that the business is not separate and apart from the business owner personally.
To keep such funds separate, at the very least, the business owner should establish separate bank accounts.
Refrain from using business assets for personal use: Another problem business owners often run into is using business assets such as a vehicle, equipment, or even company funds as the business owner's personal property.
By doing so, the business owner again provides an appearance that the business is not separate and apart from the business owner personally.
While refraining from the personal use of such business assets is the best practice, at the very least, a business owner that occasionally uses business assets for personal use should document them to set forth that the use was not gratuitous (i.e.
compensation, loan, etc.).
Observe business entity formalities: Finally,many business owners forget to follow business entity formalities such as forming internal documents and conducting formal meetings.
For example, a corporation should have a set of bylaws, its directors
should have at least one meeting a year to manage the business and at least appoint the officers, and the shareholders should have a meeting to vote on certain corporation issues, particularly appointment of the directors.
By failing to follow these corporate formalities, the business owner leaves the appearance that the business is not a separate legal entity.
While the aforementioned business practices are helpful in protecting the business owner, it is recommended that the business owner consult with an attorney and a tax advisor to ensure the most appropriate structure for the business, adequate legal protection, and compliance with federal, state, and local laws.
Lance P.Maiss is an attorney with Senn Mulemans LLP in Reno.
