Many entrepreneurs understand the benefit of small business incorporation, but they don't realize how easy it is to lose their "corporate status" if they get sued or end up in bankruptcy. This is dangerous because then the court can come after their personal assets (like their house, car, savings, etc)!
Today, I will review a little bit of why incorporating is so important for small business owners, and then tell you five simple steps you can follow to protect your personal assets, even if your business gets sued or goes through bankruptcy.
Small business incorporation makes sense for a couple of reasons. First, because it protects you from personal liability, and second, because it offers you some great tax advantages. For today, we're going to just focus on the personal liability part.
When you incorporate, your business becomes like another person. This other person has it's own bank account, it can own things like property, and it can take risks. Even if that "other person" (your business) goes completely bankrupt or gets sued, you are safe (assuming you do everything correctly).
This is important because many new businesses fail, but you as the entrepreneur don't want to fail. You want to pick yourself back up and start your next business which will be even more successful. Failure is a necessary way to learn, so we want it to be as painless as possible. Small business incorporation is the key to doing just that.
When everything works like it should, then yes, you personally are protected. But there are certain situations where your corporate status doesn't help you out, and every business owner should be aware of them!
You see, setting up a company gives you so much protection from liability, that unethical people in the past have tried to take advantage of it. They have gone through small business incorporation just to create "shell corporations", or businesses just for the purpose of liability protection, to help them get away with various crimes.
Of course, the law had to be modified to weed out these people and make sure they were appropriately prosecuted. But in the process, the requirements for honest small business owners became tougher. Some extra steps are now required to make sure your corporate status stays intact.
By the way, whenever a court decides to waive the corporate protection and actually prosecute the owners behind the company personally, they call it "piercing the corporate veil". (Lawyers always like to come up with fancy names for things.)
Following are the top five ways to protect you personal assets after going through small business incorporation. Make sure you do these correctly, and you can be sure that even if your business experiences a colossal failure, or gets sued out of existence, at least your personal assets are safe and you can start over.
1. Never Engage in Fraud or any Criminal Act
This sounds simple, but many small businesses owners unknowingly break the law. Never sell a product you know is defective or doesn't work, misrepresent something in your advertising, forge any signatures, or pull a bait and switch (offer a great deal to get people in the door only to tell them it is out of stock so you can sell a substitute.) Run your business honestly and with integrity every day, and it will pay off in the long run.
2. Never Misrepresent Your Corporate Officers or Members
Don't ever lie about who is involved in your company. When it comes time to ask for investors, or get people to support you, you may be tempted to exaggerate about who is actually working with you. If they haven't actually signed your operating agreement (an important step in small business incorporation), then they aren't your partner.
3. Make Sure Your Follow All Corporate Formalities
If you are going to claim you are a company, then you'd better act like a company. Small business incorporation requires plenty of little steps that can be easy to forget. That means you have to file all important documents and keep records of them (your operating agreement, articles of incorporation, and DBA for example). You also have to keep detailed financial records. You could pay a lawyer to put all these together for you, but this will cost you thousands of dollars. I recommend taking the time to learn these relatively simple steps yourself. There are some great resources out there.
4. Keep Your Business and Personal Assets Separate
The business has to have it's own bank account. The money in that bank account is not your money. It belongs to the business. In fact, if you decide one day come along and take some money out to buy yourself a Hawaiian vacation, that is called embezzlement (a crime)! Often, the first time through small business incorporation, new business owners (especially if they are the sole owner) don't understand this concept. The money in the company is not theirs. The company is like a separate person, and all assets must be treated as such.
5. Never Treat the Business' Assets as if They Were Your Own
Don't deposit your personal checks into the corporate account. Don't use company money to finance your personal life and hobbies. Don't lend the company car to your buddy for a weekend excursion. Don't set up a cot in the back of the office and start living there! Again, the business and yourself are two separate people. Treat them accordingly.
With these five basic steps, you can be sure your small business incorporation holds up in court in the event your business goes under.
Many successful business people, from Donald Trump to John D. Rockefeller, went through periods of ups and downs in their life. Not every company they bet on was a success. But they managed to survive and lived to fight another day because they where smart enough to go through small business incorporation correctly. They followed the above five steps to make sure they wouldn't lose their corporate status in the event of a lawsuit. They made sure that their personal assets were safe, even if the company went bankrupt.