Piercing The Corporate Veil
Yet another MBA Monday topic comes from the comments of last week's post. This series is turning into a conversation which makes me very pleased.
Mr Shawn Yeager said:
I said last week that forming a company is the best way to "putting a buffer between you and the business." But as Shawn and others point out in last week's comment thread, you can't just pretend to be a business, you have to be a business.
As a recovering lawyer, and a serial entrepreneur, I constantly have associates, friends, and family coming to me for advice on formation issues (amongst other things). I think your high level overview leaves out something that always comes as a surprise to these people: the concept of "Piercing the Corporate Veil" of liability protection.
As you know there are certain rules, forms and procedures which must be followed as a liability shielded entity, be it S Corp, LLC, C Corp (or even as a limited partner). To not follow these forms strips the liability protection away from the company and exposes the person to personal liability as if they were a sole proprietor. For some reason, people are always surprised by this. Situations arise where records are not kept, annual meetings are not held, control is exerted, or personal funds are co-mingled with the business. When the company is involved in litigation, the owners find themselves on the hook. Depending upon the jurisdiction, any of a laundry list of things could wind up stripping the protection away.
"Being a business" means separating your personal and business records, separating your personal and business bank accounts, treating the business as a real entity, having board meetings, taking board minutes, doing major activities via board resolutions, following "due process."
If you don't behave as a real business, you could find yourself in a situation where someone, most commonly someone who is suing your business, can come after you (and your business partners) personally. And then you are going to say "but what about the liability limitation the business provides?" It may not be there for you.
That's called "piercing the corporate veil". And you should take that threat seriously. So once you create a company, treat it seriously, follow the rules, and do it right. Once again, if you have a good lawyer, he or she will lay this all out for you and even give you many of the tools to do this stuff right.