Is Your Business Protected Against These 3 Risks?
As an attorney, I speak to business owners every day about risk. Not about avoiding risk, but rather the importance of entering an unpredictable marketplace prepared for its inherent perils. In my typical conversation about how to start a business intelligently, I speak about three sources of risk: the IRS, the rapacious judgment creditor, and your business partners.
Risk #1: The IRS is trying to collect more taxes from you
If your business does not have its financial books and corporate paperwork in proper order, you’re leaving yourself open to more scrutiny from the IRS. Ultimately, their goal is to find faults that would increase the taxable income of the business and reduce its deductions.
You can reduce this risk with proper bookkeeping and tax reporting, but a professionally prepared, well-organized corporate governance folder (“the corporate book”) is one of the best ways to protect your company and prepare for any complex issues in the future.
Risk #2. The Rapacious Judgment Creditor is trying to take your home away
Every day that you go out into the marketplace, you expose your business to potential claims of creditors: for unpaid debts, breached contracts, or other injuries. Your company is exposed, but if the company is a limited liability entity—an LLC or a corporation—your personal assets should be protected.
Nowhere in the world does the predatory legal mind thrive more than in the area of suing companies. When you open your doors for business, you naturally invite interaction—and most transactions should be easy. After all, you know what you’re doing, and you do it well. But out in the world, a little bit of crazy goes a long way. Small misunderstandings can blossom into major disagreements or even lawsuits.
A person who brings a lawsuit against your business is known as a Plaintiff. If they win the lawsuit, they are considered a “Judgment Creditor” since the business now owes a judgment (money) to the Plaintiff (he’s a creditor). Smart Plaintiffs will be represented by a lawyer. The Plaintiff’s Lawyer is a special type of attorney: creative, unyielding, opportunistic, sensitive to your inadequacies—and he or she wants to “pierce the corporate veil” of your limited liability entity. In doing so, your personal assets would become a target.
To strengthen the protection of your limited liability entity and insulate your personal assets from liability, you need to set the company up in a professional manner—one that will survive the scrutiny of this highly creative menace. You can accomplish this by having a properly organized corporate book that is set up in advance. Make sure this is being professionally updated on at least an annual basis.
Risk #3. Your business partners can screw up your life
If you are going into business with another person, having properly prepared internal governance documents is particularly critical. That’s because the company (and you) will be affected in a major way when any life-altering event occurs in your life or the life of a business partner. You’ll thank me for this suggestion if your business partner dies, files bankruptcy, gets married or divorced, gets a DUI, or wants to sell out of the company.
A multi-member LLC operating agreement is a stack of paper about two to five times thicker than one for a single-member company. In going from one owner to two, that extra person creates complexity. There are simply more things that can go wrong—and it’s important to plan ahead for those potential pitfalls.
What you can do to protect your company & yourself
I implore you to do two things: 1) get your corporation or LLC set up in a professional manner, and 2) update the corporate book every year. You should think of this as a substantive necessity, not a luxury. If the IRS or an aggrieved person comes knocking, or if your business partnership goes South, you will be thankful you did this work in advance.
Create a liability limiting company to protect your assets
To minimize unnecessary injury and loss caused by these categories of risk, a company’s founders should contemplate creating a liability limiting company, either in the form of an LLC or a corporation.
Limited liability is still very valuable even if—maybe especially if—you are just starting a single-owner service business. Again, you don’t set up a company to completely avoid risk; this is impossible when we go out into the market to conduct business. Instead, we are trying to limit owners’ personal liability to their investment in the company—and insulate owners’ personal assets separate from the liabilities of the company.
Consider medieval castles. The LLC is like the outer wall of a medieval castle. In simple terms, the outer wall faced the outside world, surrounding the castle. The wall was often two layers thick and multiple stories tall. Within the walls, defensive forces stood guard and fought against marauders. During peaceful times, commerce took place within the walls. People gathered, life happened. When attacked, the outside wall was the castle’s first layer of defense, where most of the action occurred—and it sustained the majority of the damage while the castle remained protected.
In your LLC, the company is the outer wall, and your castle is your personal assets. When you invest in your company, the money and property (and time) you invest is put at risk. This is a reality you should become accustomed to if you are going to start a company. But if the company is set up well—if you follow standard business and accounting practices and you run a legitimate operation—then your personal money and estate should not be imperiled.
Premeditate risk through internal governance
If you are contemplating going into business, I implore you to get your internal governance documents professionally prepared…and to get them signed before you start taking in money.
The internal governance documents of a company are its rulebook, creating the law by which the company is governed. Your lawyer will discuss the type of document you need, but it might be an “Operating Agreement,” “Bylaws,” and/or a “Buy-Sell Agreement.” Which one you need will be determined by the type of company and its structure. Whenever you ask a lawyer the question containing the words, “what do we do when…,” they are often going to go back to the Operating Agreement for the answer.
The governance documents are a toolkit. They predict (at the beginning of your business journey) the obstacles that may appear. The documents provide solutions to the main problems that a company may face. While we cannot predict the future—nor the difficulty to be faced overcoming obstacles as you proceed—the operating agreement is essential in keeping your company alive and healthy.
Build a relationship with your attorney
I encourage you to use this opportunity as a means to get to know your lawyer. As you run your company, you will need legal advice from time to time—and having someone to rely on who knows the inner workings of your company is an invaluable resource. While the initial cost savings may tempt you to use a DIY, online resource, you will be missing an opportunity to start a relationship with a lawyer who is going to think deeply about and give you holistic advice regarding your company while helping you set it up. Look for an attorney who charges flat fees for this work, gets it done quickly, and does it right.
If you’re in the process of starting a new company in Asheville, I invite you to contact my office to schedule a consultation. Craig Associates, PC supports Asheville’s entrepreneurs by providing outsourced, in-house counsel to ensure your business has its bases covered. We want you to succeed and to achieve the dreams that are the foundation of your company.