The new year is about making resolutions and positive changes for the new year. Here is a list of five things you can do today to protect your personal assets from the liabilities of your business.
1. Incorporate your business
The most important thing you can do to protect your personal assets is to create a separate entity for your business, especially if there are multiple owners. If you don’t have a separate entity for your business, then you (and your co-owners) are responsible for all the debts and other liabilities of the business. So if someone chokes on a piece of meat served in your restaurant, they can sue you and go after your house, car, boat, etc.
The most common entities are the corporation and the limited liability company (LLC). Each has its benefits and can be appropriate in different situations - talk to your small business attorney about which will be best for your business.
2. Follow all corporate formalities
Once you have a separate entity set up for your business, you need to follow the rules for maintaining the protection afforded by the entity. This is going to be found in your state’s corporation/LLC laws.
In Ohio, both LLCs and corporations must maintain a list of members/shareholders and their interest in the company, and maintain all “corporate documents” for the company (e.g. articles of organization/incorporation, tax records, bylaws/operating agreement/shareholder agreements). Corporations, in addition, must have a board of directors, hold annual meetings, and keep minutes of all meetings.
If you fail to follow these requirements, someone could use that as evidence to try to hold you personally liable for company debts - something you are trying to avoid by setting up an entity in the first place.
3. Maintain separate personal and business accounts
Every business should have its own set of bank accounts. It makes the IRS happy (and really, isn’t that enough in itself?). It helps keep business creditors from your non-business assets. It allows you to keep track of how the business is doing financially. It is verification to yourself and others of your commitment to the business.
Where you set up the accounts isn’t vitally important. There are advantages and disadvantages to both the large regional/national banks as well as the small community banks and credit unions. I do recommend choosing a bank that is different than where you have personal accounts - it makes keep things separate that much easier.
What is important, however, is to find a small business banker (in small banks this is often a manager) who you can work directly with and call up whenever you have questions. Establish a good business relationship with this person. They can help guide you through bank rules and paperwork, often can recommend other service providers such as accountants, and may even be able to refer a client or customer.
Make sure you set up a business account and not a personal one.
Once the business account is set up, there is one rule to remember: all business income goes into the business account, and all business expenses come out of the business account. If a customer or client pays you, that goes directly into the business account (make sure the payment is made out to the business). When you have bills to pay for the business, those expenses need to come from the business account. To pay yourself, write a check from the business account and then deposit it into your personal account. If you need to put money into the business, write a personal check out to the business and put it into the business account. Which leads us to…
4. Keep track of all equity and loans made by owners to the business
When you or another owner puts money into the business, it can fall into one of two categories: an equity buy-in or a loan.
When you make an equity buy-in, it increases your interest in the business. It is a long-term investment that you hope will result in profits. If you put some of your own money into the company to get it started, that was likely an equity buy-in. An equity buy-in does not have to be monetary; anything you put into the company, including labor, intellectually property, equipment, space, or even a list of contacts, can be considered an equity buy-in. Your equity buy-in determines your percentage of interest in the company, which can effect voting and profit allocation rights.
A loan is an infusion of cash (normally) into the business that you intend to get back within a relatively short period of time, either with or without interest. The distinction between a loan and equity buy-in is important because when you make a loan to the business, you become a creditor and are entitled to be paid back along with all other similarly-situated creditors of the business.
Keeping track of these is important because 1) it is required as part of your company’s corporate formalities, 2) it gives you a more accurate picture of the business’s financial situation, and 3) it shows the profit and voting rights of the owners.
5. Sign all contracts in the name of the business
Business contracts should be in the name of the business. If you buy supplies from a distributor, make sure the purchase agreement has the business as the buyer. If you lease a space, make sure the business is listed as the tenant. If you open a bank account or line of credit, make sure it is in the name of the business.
When you sign these contracts, make sure you are signing in your official capacity with the company, and not as you individually. The proper way to sign on behalf of the business is:
By: Your Name
Signing this way ensures that the other party knows you are signing on behalf of the company and not as yourself. If they believed they were dealing with you as an individual and you just signed your name without the above signature block, you could be held personally liable for the agreement, even if you have property formed an entity and followed all the other requirements to maintain your liability protection.
A caveat: there are many times, such as when applying for a loan or signing a lease, that the other side will require you to personally guarantee the loan or lease payments. If you are able, try to negotiate away from a personal guarantee. It can’t hurt to ask, and if the other side agrees, you can avoid being personally liable if you are unable to follow through on the contract.