Note: This is the first of a series of articles for new business startups and owners.
Entrepreneurs who want to start a new business, or buy an existing business, should ask the question: how do I protect my personal assets when I start or buy the new business? Unless the business is set up correctly and managed correctly, business owners face the risk of exposing personal assets to business and third-party creditors.
New business owners face risks through the life of their business, from many sources, including disagreements with vendors; uncertain or declining cash flow; electronic data breaches; warranty and product liability issues; and third party liability (for example, slip and falls), to name a few. These risks can lead to the exposure of the business owner’s personal assets to third party creditors in some cases. Careful planning and setup of the new business will establish a liability shield and help maintain that shield against liability to outsiders, while helping the owner to focus on running the business.
Sole proprietors always face personal liability for all business debts and liability. A sole proprietor is someone who owns and operates a business directly without the limited liability protection given by a business entity – a limited liability company (LLC) or corporation. With few exceptions, new business owners should always operate their businesses through an LLC or corporation). All 50 states have laws limiting the liability of the owners of LLCs and corporations for the debts and liabilities of the business.
The primary steps of reducing personal exposure to business liabilities can be summarized as “Form, Operate, and Comply.”
Step 1: Form a business entity, either an LLC or corporation (the majority of new business entities in Washington state are LLCs)
Step 2: Operate all aspects of the business only in the name of the business entity
Step 3: Comply all rules to legally maintain the business entity
By following these basic steps, new business owners substantially reduce their exposure to business liabilities. All business owners should be careful to avoid the application of “corporate disregard,” which is a theory that plaintiffs’ lawyers will use to pierce the protection given by the business entity.
Corporate disregard occurs when a business owner abuses the business entity rules to the point that the owner faces personal liability exposure. Two things have to occur for corporate disregard to apply: (i) the corporate form must be intentionally used to violate or evade a duty and (ii) disregarding the corporate shield is necessary and required to prevent an unfair loss to the injured party. (The term “corporate” originated from court decisions involving corporations, but the theory of corporate disregard applies equally to LLCs).
If a judge applies the theory of corporate disregard to a lawsuit against your business, it may result in the stripping away of corporate protection and the exposure of your personal assets to substantial claims.
Later articles in this series will discuss how corporate disregard can occur and how to avoid its application. Please follow Lucent Law for further helpful information to help you get your business successfully launched and achieve your business goals.