The Second of Five Deadly Start-Up Decisions: Ignorance

business typesThe Second of Five Deadly Start-Up Decisions is “willful ignorance.”  The old phrase, “you don’t know, what you don’t know,” is true.  Most of the time, general ignorance isn’t much of a problem.  Of course, if you have been on social media recently and your head has exploded from things like flat-earthers making a comeback, you would probably argue with me on this point. Ignorance is not in-and-of-itself a problem, because you have time to learn and grow – it is part of life. However, sometimes this lack of knowledge is actually the result of willful ignorance. Especially, when you are talking about basic business principles for the small business owner.

The second deadly issue that we often see troubling businesses is the lack of a basic understanding of business structure. In other words, a lot of small business owners don’t take the time to learn a little about what a “corporation” actually is before they start to do business. In its most basic form, a “corporation” is an entity separate from you by which you do business. Lawyers call it a “legal fiction,” because it doesn’t actually exist – it isn’t a thing. But, this “fiction” may be very important to the small business owner for a variety of reasons, and therefore, you should know what it is and why you want to be one. Yes, you really SHOULD be a business entity – not just a name on the business card.

The idea of doing business as a sole-proprietor without having a formal business structure is no longer feasible in today’s business environment. Frankly, with the ease with which you can create a corporation, you would be a fool to do business without first creating a business persona or “corporation.”  I know that is probably strong language for some people, but many of the folks that might feel that way don’t really understand what a “corporation” actually is. “Corporations” (which come in many forms) are completely separate entities from their owners, which can transact business, hold debt, hold property, and may have separate tax structure. They range in form – LLCs to C-corps – but each has the same basic characteristics that every business owner should be aware of.

Founding an actual “corporation” is important because you need to protect your family or personal assets. Simply put, because a “corporation” is a separate entity, it has separate liability – it can be sued separately and (under most circumstances) your personal liability is separate. While there are lots of other benefits in having corporate status, most business owners depend on separate liability. But, once established, you need to maintain the corporate structure separation. You must understand that merely creating the corporate entity does not maintain liability protection – your corporation must also act like a corporation. If you do not act like a separate entity, you will quickly lose corporate protection. In other words, what we call “the corporate shield” will be useless to protect you.

The single easiest way to destroy corporate protection is to prove “co-mingling,” which is mixing your personal and corporate assets or debts. In many closely-held (often family-owned) businesses, owners often mix personal and business assets, sometimes without even realizing it. It may seem silly or too formal, especially with LLCs, but you must keep the finances and decision-making separate between your personal life and your business life. If you take money out of the cash register for personal use, you may be destroying your corporate protection. Really? Yes. Think of it this way, you wouldn’t take money out of your friend’s pocket without some understanding of who owns that money, so don’t do it in your business. You must respect the corporation as a separate entity.

Moreover, you should also understand the amount of formal administrative stuff that you need to do to protect your corporate structure. Do you need to have an annual meeting? Do you need an operating agreement? Do you need to file a separate corporate tax return? Each corporation has different requirements, and a brief bit of research can help set-up your yearly corporate calendar in such a way that accomplishes these tasks easily, so that your corporation is protected going forward without unnecessary effort. Taking the time to understand your corporate structure and what it takes to protect it can save you significant heartache should you ever end up in a lawsuit.  You can test yourself by looking at the questions in this paragraph – if the topics seem unfamiliar or you don’t know the answer to each of these questions, you may want to learn a little more about your corporate structure and how to better protect yourself in the future. Trust me, some business advice now, even if you have to pay for it, is much cheaper than the lawsuit that might happen later.

Post a Comment