Yes, business liabilities can become your personal liabilities – if you don’t pay attention.
Entrepreneurs form business entities such as limited liability companies, corporations and limited liability partnerships to protect their personal assets from business debts. Usually, the owner’s risk is limited to the amount invested.
Unfortunately, you can get into trouble with your entity so that the business liabilities become your personal liabilities. The good news: Avoiding that trouble isn’t difficult. You just have to remember a few simple rules.
First, whenever you’re doing business it must always be in the exact entity name. If you’re in business as Acme Industrial Enzymes Corp., that exact name should appear on all of the company’s checks, contracts, invoices and employee business cards. Never use a shortened name, such as AIE Corp., or any other name, unless you’ve filed a fictitious name registration with the state. Even then, the true name should still appear on all business documents. Also, make sure the fictitious name is actually owned by the entity and not its owners.
Next, when signing for your business, make sure all contracts are in the entity’s name, always include your title with your signature (John Smith, President) and cross out terms making the signer a personal guarantor.
Recently, I heard of a situation where an owner was sued when he signed a contract in a slightly different corporate name and didn’t include his title. The creditor claimed the owner was acting as a sole proprietor and was personally liable when the corporation didn’t pay. The owner paid a settlement when a few simple changes would have protected his money.
Third, remember that if you, personally, do something that injures another, even on the job, you’re probably personally liable.
Take, for instance, a one-person bakery. Our entrepreneur rises early to bake the bread then drives around town making deliveries to local shops. One morning, he causes an accident. Even though the bakery owns the truck and operates the business, the entrepreneur will be liable because he was driving.
So, you should always have adequate risk and casualty insurance.
Fourth, you can’t treat the entity as your personal slush fund. Being in control, you could be liable to its creditors for paying out or taking money improperly.
For example, you can’t pay yourself a dividend, remove assets or bleed the entity dry, leaving it penniless so it can’t pay creditors. You also can’t pay debts the entity owes you and other “insiders” before paying outside creditors. You can, however, pay yourself your usual salary and other customary expenses. But, be careful about giving yourself a large raise as the ship is sinking.
Fifth, make sure you follow the formalities of your entity.
Pay the annual fee so your entity is not administratively dissolved or terminated. Keep your entity records and documents properly. Actually have member/shareholder/partner and manager/director meeting minutes. Issue stock certificates and adopt bylaws.
After all, you won’t know you have a problem until you need the protection!
Finally, avoid guarantees whenever possible. Guarantees are enforced all the time.
Years ago, another lawyer told me that 10 feet of water over his client’s head was the same as 1,000 feet. Many owners take comfort in this theory when considering a guarantee. But, remember, even if you can’t pay it, a judgment will prevent you from borrowing money to buy a home or car.
You probably won’t get out of guarantees for banks. But don’t accept them as “standard” in leases and supplier contracts. Often, you can provide a larger deposit or play one supplier off against another to avoid the guarantee.
If you pay attention to these areas, you can get the most liability protection from your business entity.