Many business owners already recognize the importance of creating and maintaining a Limited Liability Company (LLC) or a corporation. In fact, some businesses might employ more than one when organizing their business structure. It’s not uncommon for campground owners to have two: one that owns the real estate, and one that owns the operating business.
Having an LLC or corporation protects you from personal liability. This is because as a separate legal entity it limits your personal liability and essentially pulls a veil over your personal assets. By using a separate legal entity, the LLC or corporation is responsible for their own debts and obligations. You can still lose the money you have invested in the company, but personal assets like your home, vehicles or personal bank accounts cannot be used to collect on business debts. Most importantly, your personal assets will be protected if an employee or even the business itself is sued.
If it sounds too good to be true, it is — but only because it requires additional work to maintain the separation, or to keep the “veil” intact. Typically, a business is protected if it employs the use of a separate legal entity, but there are instances in which the court will “pierce the corporate veil” and hold the owners personally liable for their company’s business debts. Unfortunately, closely held corporations and small LLCs, which are owned by one or two people are more likely to have their veils pierced.
When will courts pierce the corporate veil? More often than not, courts will pierce the corporate veil when there is no real separation between the company and its owners. If you are trying to avail yourself of the protections of using a separate entity, then it needs to be as separate as possible. The court will pierce the veil if it finds that the owners of the LLC or corporation are operating as if it doesn’t exist. For example, misusing the business checking account to pay personal bills. To be safe, that veil better be a wall that separates yourself and your personal assets from your companies’.
Courts will also look at whether the company engaged in fraudulent behaviors, whether the company was adequately capitalized (had enough funds to operate as a separate entity) and whether corporate formalities were maintained.
What can you do to protect yourself? First, follow corporate formalities. This means holding annual meetings of members if you are an LLC, or directors/shareholders if you are a corporation. Give proper notice to the members/shareholders/directors before the meeting or get a waiver of notice. Keep minutes of those meetings and have copies of any resolutions for decisions that were made. Make sure that the entity has up-to-date governing documents, an “Operating Agreement for LLCs” or “Bylaws for a Corporation,” and that you are following the procedures you laid out in those agreements.
In addition to annual meetings, any large company business, such as the sale or purchase of real property, or a major refinancing should be done in a special meeting. Again, followed up with the minutes and a resolution. These documents should be kept in your corporate binder, so that you can produce them as needed.
Second, don’t let your personal assets fraternize with your business assets. As a small business owner, it might seem easier to let your assets all play together, but they should not be friends! For example, if a business owner uses some of their business assets for personal use, such as writing a check to pay a personal bill, this is called “commingling of assets.” You should never use the company account for personal use or deposit checks made out to the business in your personal account. If you do, this tells the court that the company is no longer separate but is instead your alter-ego.
Keep the bank accounts all separate, accurately record transactions in your checkbooks, don’t tell creditors that you will personally guarantee any company debts, make sure you capitalize the business enough that it could operate independently, and most importantly, make sure everyone, including your grandmother, knows that they are dealing with your business and not you personally, so put “LLC” or “Inc.” on all your business cards, letterhead and signage.
Realistically, it may not be feasible to never personally guarantee a contract, but you should make a practice of doing it as seldomly as possible. This can be accomplished by making sure your company documents all state the name of your LLC or corporation and that when you sign documents you sign them in your representative capacity. Further, don’t be afraid to call up a vendor after a couple years and ask them to tear up your personal guarantee, you’ve proved that the business can pay, and they should no longer require it.
As a small business owner your LLC or corporation is as close to you as your family, but to protect your personal interests, to keep the veil intact, treat your separate legal entity like that crazy relative you keep tabs on but never want to spend too much time with.