A
business entity can provide personal liability protection for its owners.
The problem is that many people start business without proper instruction on
how to run and manage agreements between parties, agreements with customers,
internal paperwork, cash controls, voting rules, state and Federal reporting
requirements and a host of other issues.
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In fact, we have found between 20 to 25 actions, behaviors, or neglected
tasks which commonly cause a business structure to be forfeited and can
result in personal liability for the owner or owners.
Here are 5 of them:
1. Using the Business for
Fraudulent Activities
YOU CANNOT, SHOULD NOT, AND SHALL NOT USE YOUR BUSINESS TO CHEAT OR
DEFRAUD! For example, John Smith gathers money from investors claiming that
he will develop a new product for his company. He never had planned to use
this money for product development. He is sued by the investors, but John
claims that his personal assets are protected since he was acting as the
president of his limited liability company. No court will honor the limited
liability company since fraud was involved. His personal assets and business
assets will be at risk.
You may think that since this is an egregious example, it won t ever
happen to you. However consider the fact that many deals struck with the
so-called motivated sellers could give rise to a lawsuit under your state s
Deceptive Trade Practices Act (DTPA) or similar statute. Sometimes the line
is not so clear. One bit of wisdom is to make sure that your agreements are
fair:
a. You also can t be wholly unfair or flagrantly one-sided when dealing
with customers. A court can always look at a one sided transaction and
either decide against you. Even worse a judge could declare that you are
using the business to promote unfair dealings. This is bad news for you!
b. ASK YOURSELF: Would you want to be the buyer/customer on the other end
of your deal? Despite popular conception you can structure win-win deals
with motivated sellers and make money. Ever hear of karma? Everything you do
to or for another person will one day be done to or for you so be fair!
2. Failure to Respect the
Business as Separate from Its Owners
YOU SHALL NOT MIX FUNDS FROM BUSINESS ACCOUNTS WITH YOUR PERSONAL FUNDS,
ACCOUNTS, ETC. DO NOT USE COMPANY MONEY TO BUY PERSONAL ASSETS, GROCERIES,
ETC. Simply put, if you do any of these things routinely (or perhaps only
once) then your business structure is not likely to hold up in court. If you
think this is another easy one then WATCH OUT, because there are other more
complex issues relating to the use of business and personal assets in the
business. For more information see some of our top-rated courses.
3. Insufficient
Capitalization:
THE FAILURE TO PROPERLY CAPITALIZE THE BUSINESS. IN OTHER WORDS, A LACK
OF RESERVES AND/OR INSURANCE COVERAGE. If your business does not have enough
capital and/or insurance to cover operating expenses and potential
liabilities then a state court will likely pierce the business entity and
hold the owners personally liable. Why would a court do this? The reason is
to find the money . Your business must have enough insurance and/or savings
to cover expenses, liabilities, and obligations. The amount of
capitalization generally refers to the total value of assets (equipment,
cash, etc.) in the company and the amount of insurance coverage. This is
another COMPLEX area because you may need more or less capitalization based
on your business type. A general rule is: The more you deal with the public,
the generally the greater your required level of capital.
4. Forgetting to File State
Reports
Your secretary of state s office will require you to keep up with reports
and state taxes (sometimes called franchise taxes and/or business privilege
taxes). If you don t keep up with these reports and/or taxes (even if
nominal amounts are owed) your business privileges will likely be revoked.
Guess what privilege goes first?: The personal liability protection.
5. Other Formalities
These include meetings, paperwork, required records, proper roles and
obligations among the parties, and transfers of ownership interests, and
more. It is very rare that we see full step-by-step and easy-to-follow
details on creating iron-clad records in these areas. For state liability
protection and the ability to satisfy IRS auditors you need to understand
these rules!
The list does not stop here, because we have found between 20 to 25 areas
which are common traps for the business owner. While we have covered 5, many
of the others are very easy to miss but just as important. Please make sure
you get proper instruction on how to run your business entity after it is
created! The true lost art is learning how to maintain the protection of
your LLC or corporation.
About the Author:
To learn more about which entity
may be best for you and how to create, run, and maintain an iron clad LLC or
corporation, you don t need a grant from the King or Queen but you should
see Mr. Barazandeh s, Incorporate for Wealth and Wealth Building LLC courses
at www.theinformedinvestor.com and www.attorneysecrets.com.
As a licensed attorney and former
business consultant, Mr. Barazandeh brings a high level a professionalism
teamed with in-depth legal and business knowledge to the world of real
estate coaching and training.
July 2007
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