When you started your corporation or limited liability company, one of the main reasons you did so was for the personal liability protection that a corporate shell provides. In order to maintain those protections, however, it’s critically important that your business abide by some very basic but absolutely necessary ground rules. Although the technical “formalities" required of corporations compared to LLCs vary, none are dispensable without risk of losing your corporate shield.
I offer this article for your review as not only a primer to the uninformed, but also a quick refresher for those already in the business world. While I can’t claim that this is complete list, it’s nonetheless fairly inclusive and I hope that it will get you started off right.
The formalities of running a corporation
Whether you’re a one man shop or a multi-national conglomerate, some formalities simply can’t be ignored. Every corporation for instance must adopt bylaws. Bylaws are essentially internal rules governing the functioning of your business. In essence, they lay out a blue print for how the business operates, and when officers and directors must act. No corporation should proceed without a corporate book that sets forth these bylaws. A secondary component of the corporate book is the stock ledger. Every business must maintain a ledger reflecting the stock ownership in the company, including the names and addresses of each stockholder.
In that same vein, the functioning of the board of directors is likewise indispensable. The board of every business should regularly meet, and detailed minutes of all discussions and resolutions should be maintained. Those minutes are subsequently adopted by the board if accurately reflecting the matters addressed and then placed in the corporate book. Any major decisions contemplated by the board relative to the business (such as mergers, executive compensation decisions, insider loans, etc.) must be voted on and adopted per the procedures set forth in the corporate bylaws.
There are a number of other (and seemingly obvious) but no less important formalities that should also always be followed. When doing business with third-parties, always do so in the name of the business. It’s important to do so in order to avoid any confusion (perceived or actual) that officers and directors are acting on behalf of the business, and not in their individual capacities.
Similarly important, always maintain a separate bank account for the corporation! Hopefully it’s intuitive, but you should never commingle personal and business funds. If you start doing so, you run a very good risk of someone (whether it’s the IRS or a corporate creditor) challenging whether the business is your alter ego. When that happens, and if you and the corporation are determined to be one and the same, you potentially open yourself up to personal liability if the other party successfully “pierces the corporate veil". The same situation can come to pass to when shareholders personally guarantee debts of the corporation. Unless done on a limited basis and per board resolution, personal guarantees shouldn’t be undertaken lightly as they can also give lead to a determination that the business is merely your alter ego.
On a final note, the corporation should make sure to do all that is legally required of it. This is true not only in terms of filing and paying all state, federal and local taxes, but also making sure that the business has secured all necessary licenses and permits that will allow it to legally operate.
The formalities of running a limited liability company
The introduction of LLCs years ago was a wonderful addition to the a la carte selection of entity types from which business owners have to choose, if for no other reason that the flexibility they offer. While the functioning of LLCs require less formality to preserve your corporate shield, there are nonetheless certain basic formalities that must be adhered. Some are identical to the formalities of corporations, such as maintaining separate bank account (and never commingling funds), conducting business only under the business name, avoiding the personal guarantee of corporate debts, and filing/paying taxes for the business. Other formalities are slightly different.
All limited liability companies should have in place an operating agreement. Operating agreements are similar to corporate bylaws, but they go into even greater detail regarding the individual members’ duties, taxation rules and distribution outlines for the members.
While rules differ between states concerning how often, members should meet regularly to discuss company business, while being sure to maintain a minutes book reflecting those discussions and any resolutions passed by the members. New York requires that members hold at least an annual meeting concerning the business. While that’s the minimum, it certainly wouldn’t be my recommendation. Given how difficult it can be to recreate a year’s worth of company business, it’s highly advisable to hold regular meetings and keep good minutes. The last thing you want to have happen is someone challenge the formality of your business and you be unable to demonstrate otherwise.
Whether you maintain a corporation or a LLC, observing the formality of your business is something that should become second nature to you. Given the precarious position that you could potentially find yourself relative to personal liability exposure should you fail to observe these simple steps, business owners have every incentive in the world to follow them to the letter.