The U.S. Small Business Administration has published online information to help a person decide which business structure is best for their situation, including a helpful table to easily compare different aspects of the various entity choices here. Our attorneys can help you decide which entity is right for you.
Owning and managing a business is a major financial and legal undertaking. Our team of legal experts can help you understand the intricacies of forming a business entity, navigate corporate formalities, make critical financial decisions, determine what insurance you need, and more. And with a LegalShield Business membership, our plans give you affordable access to legal consultation on a variety of business matters.
HOW DO I DETERMINE WHAT TYPE OF ENTITY IS BEST FOR MY BUSINESS?
CORPORATE FORMALITIES, LIMITED LIABILITY, AND PIERCING THE CORPORATE VEIL
It is important for a business to maintain a legal entity status that is separate from the legal status of the individuals involved in the business. This legal entity status separation keeps the individuals’ and business’s liability separate as well.
Limited liability refers to the separation of a business liability and a personal liability, and it is one of the most important protections offered to individuals involved with a registered business entity. Without these separations, owners, shareholders, and directors of the business could be found personally liable for the business’s debts and lawsuits against the business.
To maintain liability and the legal status of a business entity, there are several administrative formalities that are required of the owners, shareholders, or directors of a corporation or LLC. Formalities may include, but are not limited to:
- Creating and following Bylaws or an Operating Agreement
- Holding board of directors meetings
- Maintaining a stock ledger and issuing stock certificates
- Setting up and maintaining a separate corporate bank account
- Keeping a corporate record book
- Filing taxes
- Conducting all company business in the name of the company, and not in your personal name
When corporate formalities are not followed, one becomes personally liable for the claims against the business and/or the debts of the business.
Once personal liability is found, persons may have the right to not only file a claim against the business, but against the individual as well. In this situation, courts may put aside limited liability and hold the shareholders, directors, or owners personally liable for the entity’s actions or debts. This is called piercing the corporate veil.
Activities that may pierce the corporate veil and create personal liability for members, owners, managers, shareholders, and/or directors of a business entity include:
- Ignoring formalities (e.g. not filing annual renewals, not appointing or electing board of directors (corporation), not holding board of directors meetings, not filing taxes)
- Comingling corporate and personal funds
- Using corporate accounts for personal debts or other personal purposes
- Using the LLC or corporation to engage in illegal, fraudulent, or reckless acts.
I HAVE A BUSIENSS ENTITY; WHY MIGHT MY LENDER OR LANDLORD REQUIRE A PERSONAL GUARANTEE? WHAT IS MY PERSONAL LIABILITY?
Lenders and landlords will often examine your business’s financials (assets and debts) during the application process for the loan or lease. If the lender/landlord determines that your business has few assets, significant debt, poor credit, or little credit history, then the lender/landlord may assume that your business is a credit risk and require you to personally guarantee, or “cosign” on the loan or lease in your personal name before they will extend credit or a lease to your business. This is to ensure the lender/landlord that, if the business defaults and does not pay its obligations under the loan/lease, you will step in personally and pay those obligations.
Signing a personal guarantee, or cosigning on a business loan or commercial lease, is a very serious financial commitment. Under this commitment, you are agreeing that in the event your business defaults on the loan or lease, the lender/landlord can sue you personally for repayment of the business loan or sums due under the commercial lease. You also are agreeing that if the lender/landlord is successful in their lawsuit against you, civil judgment can be entered against you personally, and your personal assets can become subject to collection efforts.
You should carefully consider whether to sign a personal guarantee on a business loan or commercial lease. You may negotiate removing the personal guarantee with the lender/landlord – they may be willing to remove the requirement in exchange for a higher down payment or higher interest rate. However, they are under no legal obligation to make these accommodations. You can also try to apply for a loan or lease with a different lender/landlord to see if they will offer a business loan or commercial lease without the requirement of a personal guarantee.
WHAT TYPE OF INSURANCE DO I NEED TO HAVE IN PLACE FOR MY BUSINESS?
Subject to very few exceptions, all employers are required to purchase worker’s compensation insurance at some point (See your state resource page to find specific details for your state requirements.) In addition to liability to the injured worker, an uninsured employer may also be fined by the state for failing to insure employees, regardless of whether an injury has occurred. The state may also order the employer to: provide the necessary insurance coverage; refrain from employing any person at any time without insuring the employee; and pay a penalty.
Commercial liability insurance (also called business liability insurance and commercial general liability insurance) is not mandatory for all businesses, but it is highly recommended that you purchase commercial liability insurance for your business and thoroughly understand the insurance policy’s coverages and exclusions.
Commercial liability insurance protects your business from financial loss resulting from claims of injury or damage caused to others by you or your employees. A policy typically covers:
- Bodily injury – physical damage to a person other than an employee at your place of business and injuries caused by you or an employee at a client’s home or workplace
- Personal injury – libel, slander, copyright infringement, invasion of property or privacy, wrongful eviction, false arrest, and similar acts that cause damage to a person’s reputation or rights
- Property damage – damage done to another person’s property by you or an employee while conducting your business
- Advertising injury – losses caused by your advertising
- Legal defense and judgments – defense against real and frivolous suits and judgments up to the limit of your coverage. Note: this generally does not include punitive damages for negligence or willful misconduct.
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