The Second of Five Deadly Business Decisions is “willful ignorance.” The old phrase, “you don’t know, what you don’t know,” is true and represents our general ignorance of things. Most of the time, this general ignorance isn’t much of 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 small business principles.
The second deadly decision 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 do a little research about what a “company” or “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.
In my opinion, the idea of doing business as a sole proprietor without having an actual company/corporation is no longer feasible in today’s business environment. If you do business without an actual “company” (filed with the Secretary of State and other requirements), YOU CAN LOSE EVERYTHING YOU OWN due to debts, losses, injuries, and a variety of other things we discuss in the litigation portion of our website.
Frankly, with the ease with which you can create a corporation, you would be a fool to start doing business without first creating a business persona also called a “corporation.” You actually have to get approval in your state, not just put a cool name on a business card or magnet on the side of your truck. (I see you XYZ Contracting.)
I know that is probably strong language for many people, but many folks don’t really understand what a “corporation” actually is. “Corporations” (which come in many forms) are merely alter egos from their owners, which can transact business, hold debt, hold property, and may have a separate tax structure. They range in form from LLCs to C-corps, but each has the same basic characteristics that every business owner should be aware of.
For most business owners, starting a corporation is important because they want to protect their family or personal assets. Simply put, because a “corporation” is a separate entity, it means that it has separate liability – it can be sued separately and (under most circumstances) your personal liability is separate if you are being sued. And, while there are lots of other benefits in having corporate status, most business owners depend on this separate liability as the basis for having a strong corporate structure. Notice though, that I said “strong corporate structure.” Under the heading of a little knowledge can be a dangerous thing, you should also understand that merely creating the corporate entity does not maintain liability protection – you must also act like a corporation. If you do not act like a separate corporation, you may quickly lose corporate protection if you are ever sued. In other words, what we call “the corporate shield” will be useless to protect you.
The single easiest way to destroy corporate protection if the case of a lawsuit is to prove “commingling,” 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 and who will pay it back. You shouldn’t do this with your business either. You must respect the corporation as a separate entity.
Moreover, you should also understand the amount of formal administrative stuff that you must 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. With a small amount of research you can help set-up an annual corporate calendar that accomplishes these tasks easily, so 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. File this under an ounce of prevention beats a pound of cure. 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.
This is the second test that you must pass on the obstacle course to success.