Forming a Corporation or Limited Liability Company: What You Need to Know
These days, forming a corporation or a limited liability company is as easy as locating the appropriate government website (typically the secretary of state of the relevant state) and following the online guide. An LLC usually merely requires supplying the necessary information to the state, including address, organizer, and registered agent, and then payment of the filing fee. For a corporation, typically an additional step of publication of notice of formation of the corporation is required.
Most people think that's all they need to do-they're good to go. However, formation of the entity is just the beginning.
Treating the Entity with RespectThe main reason people form an entity is for liability protection. That is, you create a corporation or LLC to shield your own personal assets from the claims of creditors of the business. Just creating the entity by filing the appropriate articles with the state does not work to achieve this goal, however. The entity must be used, not just formed, and it must be treated with respect.
What I mean by treating it with respect is you have to move all assets and sign all contracts, insurance policies, leases, bills of sale, invoices, etc. under the umbrella of the company. You must keep your assets and the company's strictly separate. If there are agreements or actions of the company that under the law would require formal resolutions, you must put them together, have the necessary meeting, vote, and if at all possible sign resolutions or actions contemporaneously or before the action taken (i.e., do not backdate).
The "Corporate Veil"The key aspect of the entity you form, be it corporation or LLC, that you are seeking to reinforce is the "corporate veil": that barrier between you individually and the company. If you play fast and loose in any aspect of the company's business-on the front end by signing agreements inappropriately or on the back end by taking money in and out of the entity without appropriate accounting-it will be very easy for a creditor to argue that the entity is merely a farce and collect against your assets personally. While the threshold requirements for "piercing" the corporate veil differ state-by-state, there is one thing that is universally true: the creditors of the entity will be trying every angle to get around the entity and collect against you personally.
Structuring the Entity ProperlyAgain, many assume that once the appropriate documents are filed with the state, you can proceed with business. Sure, you can, but if you have any partners who own any share of the business with you, you're asking for trouble. What if your business partner dies? What if you and your business partner disagree on the ownership percentage? What if you and he have a falling out generally?
If you have any partners at all, there are documents that you should put into place to deal with these contingencies and others. For the limited liability company, this is the operating agreement, which can set down ownership percentages, how profits are paid, buy-sell agreements, restrictions on transfers, and just about any other agreement that the partners feel is important. For the corporation, typically you will want a separate buy-sell agreement and possibly a shareholder's or other form of agreement.
Your Trusted Partner Could Be Replaced or LeveragedOftentimes, I run into the situation where my clients or potential clients tell me that they get along beautifully with their partners or as partners and that they cannot imagine a scenario where they would disagree. I tell them they are fortunate to have such partners-we all would want that arrangement-but that there are circumstances where your partner, due to family situations, will feel compelled to change direction, or where other persons (creditors, soon-to-be divorced spouses, executors, heirs) become involved or even step into the interest of your partner. It's important to get it down in writing for everyone's mutual protection.