So you’ve decided to start your own business? Congratulations! While you focus on perfecting your product or service, finding distribution channels, and devising a marketing strategy, you could be missing important legal issues that must (MUST!) be dealt with as soon as possible.
Perhaps most importantly, you and your attorney need to think about your choice of entity or entities. If you are opening up shop with equity and/or sweat investment from other people, you have created a general partnership, whether you wanted to or not. While general partnerships have been recognized as a business entity for over 100 years, they have fallen out of favor with attorneys and business owners alike. This is because doing business as a general partnership is dangerous, plain and simple. By rule, every partner in a general partnership is responsible for all debts of the partnership, including debts that the partner doesn’t know about and debts arising from torts in which the partner was in no way at fault.
The simple solution is to form an LLC. This is true even if you’re starting the business by yourself. The LLC designation costs $130 to file in Wisconsin, plus $25 each year to file an annual report. In Illinois, these fees are $500 to start and $250 each year for the annual report. These expenses are miniscule compared to the protections those three letters provide. Say, for example, that your partner embezzles money from one of your clients. Without the LLC designation, a judgment would leave you liable to the aggrieved party to the full extent of their damages, even if your partner were available and able to pay. Organizing as an LLC protects your personal assets, so that only the money you have directly invested in the business is vulnerable. To be clear, the LLC designation would not protect your partner in this situation, nor would it protect you if you were involved in the scam or knew that it was happening.
I’d like to illustrate with another example. If one of your employees commits a tort on the job, your business is liable for any and all damages (you can require your employee to indemnify your business for things like this, but that’s another topic for another day). Say he was texting his friends about fantasy football while delivering your product to vendors, wasn’t paying attention and wrecked an ongoing construction project. There were no injuries, but the multiple judgments against your business have maxed-out your insurance coverage.
As long as you’ve been complying with simple requirements, the limited liability status will protect your personal assets from these judgments. However, a skilled attorney can help your business survive this incident as well, even as the LLC through which it operates is wiped out. Of course every situation is different, but it may be possible to keep your vendor and supplier contracts, good will and intellectual property by validly transferring these rights and responsibilities to a new LLC.
By now, the advantages of limited liability entities should be obvious. However, the LLC is not always the best form to choose for your new business. If you plan to raise a lot of equity capital, you’re better off forming a corporation ($100 to file, $25 each year for the annual report in Wisconsin; $150 to file, $75 each year for the annual report in Illinois). Angel and venture investors will often only invest in corporations, as they value the ability to take the company public, which can realistically be done only with corporations. In addition, corporations may reward employee excellence with stock options, while LLC’s cannot.
When counseling your business on its initial choice of entity, a good lawyer will often find that it makes sense to organize or incorporate multiple business entities to be run in conjunction with one another. Revisiting the example from before: I may have set up your business as a corporation owning a number of LLC’s- one to operate the production business, one to operate the delivery business, and one to own the real estate. As long as each LLC were in compliance with state reporting laws and properly managed - with separate, adequately capitalized bank accounts - a civil suit for damages against the delivery LLC would have serious difficulty “piercing the corporate veil.” Thus, your business’ production operations and real estate holdings would be well protected.
Taking it one step further, you could have segregated delivery operations into an LLC staffing the drivers and separate LLC’s for each delivery truck. This would leave only the staffing operation (with its few assets) and the truck involved in the accident accessible to judgment creditors (Bonus: if the company were to lease the trucks it would have even less to lose). Wisconsin courts have not yet developed this area of law, but at worst these protections would likely reduce any settlement your business may have to pay.
Of course, a good lawyer will get to really know your business to determine whether the protective benefits of defensive entity structuring would outweigh its additional legal and accounting costs and administrative burden.
If you’re just starting your business, or think that some of the strategies discussed in this article may help protect your business assets, please don’t hesitate to give Wayne Business Law a call.
This article first printed in the Winter 2010 Wayne Business Law Quarterly "Think of Everything, Act Accordingly."
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