One amazing feature of starting a business in the United States (and most western countries) is the ability to limit your liability. Meaning, what you invest in the business is the only thing at risk…not your entire wealth, nest egg, home etc. But, that’s only if you do it the right way. It’s easy, but you still have to follow some rules.
This article assumes that you appreciate how amazing liability protection is. If you are new to the topic and unconvinced as to whether or not you need an entity (like an LLC), learn more here.
The liability protection began with corporations and now is seen in many other entity forms. The “corporate veil” is the term used to describe how an entity, like an LLC or corporation, protects your personal assets. When you hear the phrase “piercing the corporate veil,” it refers to a plaintiff’s lawyer trying to access money outside the business – usually personal assets, or assets of another business. In other words, setting aside the personal liability protection of that entity to reach you personally.
HOW TO KEEP YOUR LIABILITY PROTECTION
Since one of the main reasons you created a business entity in the first place was to protect your personal assets, it’s crucial to understand how you can protect yourself from having a plaintiff’s lawyer pierce the corporate veil of your business.
The idea here is that state’s will provide you with this protection but, in return, you must prove that you are actually a business and operating that business in good faith to take advantage of these protections.
Don’t Commingle Funds
Commingling funds happens when a business and personal account are not separated but are mixed together.
To prevent this situation, follow proper accounting procedures. Never use your business bank account for personal reasons. Only business-related income and expenses should be going and in and out of that account. Otherwise, you are risking commingling.
Maintain Corporate Records, Status, and Formalities
It’s not enough to just file an LLC with the Secretary of State and just forget about. Make sure you stay in good standing. This means paying fees that your state requires and updating them when you change addresses. You should also have formal documents like operating agreements and bylaws. If you are a corporation, you are likely required to hold meetings, keep minutes, and utilize mechanisms like resolutions. If you are an LLC, you likely have fewer record keeping requirements. The lesson here is that you must act like a business on paper.
Don’t Use Your Personal Signature On Documents
You go through all this effort to set up your LLC and maintain proper accounting and business structures, but then you sign documents with just your name. This means you are personally signing. Instead, start signing as a member of your company. It looks like this: “Wesley Henderson, as Managing Member, Quick Counsel, LLC.”
(Note: There are times where you will be asked to personally guarantees things like a loan or a lease agreement. Only sign personally if you intend to be personally liable and put your personal assets on the line.)
It Takes Effort
You won’t gain maximum protection from your business entity just by setting it up in the first place. You need to continually and consistently look and act like a business on paper and in practice.
Action Steps for Liability Protection
- Don’t commingle funds: Create a separate bank account for your business if you don’t already have one and use it exclusively for business-related expenses and income. While it’s okay (not ideal) to pay for business expenses with your personal account, it is not okay to pay for personal expenses with your business account.
- Act like a business on paper: Keep up with maintaining and filing paperwork and paying fees as required by your state for your business type. Check out your state’s Secretary of State website to find out what you need to do.
- Sign on behalf of your business: Stop signing business documents with only your name. Sign as an member of your company.
- If you are not using an LLC or other entity, get one immediate…here.