If your business has its legal planning in place – your personal assets will most likely be protected from any liability that might occur as a result of your business operations. Following the five key guidelines below will help to create and maintain your business as a separate entity- protecting your family, home, and other personal assets from being “up for grabs“ should someone sue your business.
A properly formed business in Colorado is legally created and regulated by state laws and thus legally separate from the individuals who own them. To retain this separation, certain legal requirements and formalities regarding the maintenance and operation of the business must be followed. If these requirements are not met, the separation may be disregarded, with disastrous consequences.
The following is a brief summary of some of the benefits of having a properly formed legal entity for your business, no matter how large or small it is:
- Protection of Limited Liability: If you treat your business as an entity, separate from yourself, it is highly unlikely that the business entity will be disregarded by a court or government agency like the IRS. If it were disregarded, the result could be financially devastating. If the business entity cannot pay its debts, whether from regular operations or from liability attaching as a result of lawsuit or government action, your personal assets would be made available to the creditors of the business entity.
- Continual / Perpetual Existence: If businesses are properly planned for the death or disability of the owner does not mean that the business is dissolved (in the case of death) or unable to conduct business (in the case of disability). Changes in ownership and management are specifically addressed in the by-laws of corporations, in the operating agreements of LLCs, and in the partnership agreements of LPs.
- Access to capital: A business entity is a more attractive vehicle for investors than a sole proprietorship. Private investors are able to invest in business entities with confidence. This confidence comes from being able to invest and receive either a debt obligation (which may be convertible into equity under certain circumstances) or a portion of the ownership of the entity.
- Potential tax benefits: The owners of corporations and LLCs taxed as corporations may be able to receive tax benefits by sheltering business income in the entity—thus reducing the owners’ overall tax liability.
- Commercial credibility: American consumers are more accustomed to purchasing goods and services from businesses than sole proprietors. This instant reputability is another leading reason individuals use a legally separate entity as the business vehicle of choice.
- Employee benefits: Under certain circumstances, the ability to offer more comprehensive and deductible fringe benefits may result from the use of a business entity.
All too often, the requirements of just keeping a small business running leave little time for the owner or owners to engage in corporate/LLC/LP “housekeeping” and “maintenance.” Without some level of diligence on the part of the owners, a gradual merger of the life of the business and the life of one or more of the owners or managers may begin. When this happens, the separate legal status of the business entity begins to fade.
WHAT YOU NEED TO DO TO PROTECT YOURSELF AND YOUR BUSINESS
The following five key steps should be taken by all business entities, even those owned and managed by only one person.
1. Compliance with the Secretary of State:
As an initial matter, you should ensure that your business entity is in good standing at all times with the Colorado Secretary of State. You will receive an annual report from the Colorado Secretary of State each year (for entities other than Limited Partnerships). It is important that you complete and return this annual report with the required fee. Even if your entity is delinquent in annual filings or other matters, it is usually very easy to bring your entity into compliance with the Secretary of State. Typically, this will involve the filing of a delinquent annual statement or, possibly, reinstating your entity if it has been deemed dormant or inactive.
2. Internal Governance in Compliance with State Law:
It is important to keep your internal entity governance up to date. This step can not be over emphasized in its importance. Being in good standing with the Secretary of State is only the initial step in having your business entity recognized as separate from you (as the owner) at some future time whether in court or by a government agency.
3. Corporate Book
The most important action item is to ensure that your business document binder remains up to date. (This binder is universally referred to as the “Corporate Book” irrespective of whether you own a corporation, LLC or LP.) The binder should contain your entity’s organizing documents (articles of incorporation or articles of organization), the operating documents (by-laws, operating agreement, or partnership agreement), evidence of ownership (signed stock certificates, membership certificates, or partnership certificates), transfer ledgers, resolutions and agreements to extraordinary actions (opening bank accounts, signing a lease, making tax decisions, appointing officers, etc.), minutes of each annual meeting (discussed further below), tax documents (such as the Request for Employer Identification Number on Form SS-4 [the tax identification number for domestic business entities], S-Corporation Election on Form 2553, Tax Returns on the applicable forms [1065, 1120, 1120-S, etc.]), required permits and licenses for your type of business, leases, loan documents, and any other documentation that is evidence of your respect for the separation of the business entity from yourself.
4. Annual Meeting
Reviewing the actions of the entity and planning for any upcoming changes on an annual basis is important. The documentation of this annual review/meeting in the Corporate Book is one of the first items a future judge will review if ever asked to disregard your entity.
5. Keeping It Separate - Day to Day
You should also make sure the following tasks are accomplished and used in the daily running of your company:
- Open a bank account (usually a checking account) in the name of your entity.
- Ensure that you can document all moneys put into your entity in return for your ownership.
- In any interactions your entity has with other commercial enterprises or individuals, make certain that it is clear that you are acting on behalf of your entity and not as an individual.
- Use letterhead on all of your correspondence and contracts.
- Include the entity designation (“Inc.,” “Limited,” “Ltd.,” “LLC”) whenever possible on business identifiers such as business cards, advertisements, etc.
- Always sign documents in your representative capacity, and not as an individual:
YOUR ENTITY NAME
by: YOUR NAME, YOUR TITLE (Manger, President, Owner, etc.)
- Ensure that all assets that are meant to be owned by your company are titled in the name of your entity and not in your name personally.
- Never commingle the funds or assets of your entity with your personal funds and assets. If you need to fund the operations of your company with your personal assets, document the transfer as either a loan or a contribution to the capital of your entity. If you need to use assets of the company for personal reasons, distribute the assets out of the company to yourself first as income, profit distributions, or a return of your capital contribution.