Owning and operating your own business can be a satisfying and profitable venture. But it’s also one that can lead to personal financial ruin.
To minimize some of the risk, many will choose to form a corporate entity such as a limited liability company or for-profit corporation. Having that separate legal identity separates owners from business-related liabilities—but only if that entity is treated as such.
Too often, owners either aren’t aware or aren’t diligent about sticking to those rules—a fumble that unfortunately and unnecessarily can lead to owners being personally liable for the debts of the business as well as any legal actions brought against the business.
Following are the eight most common mistakes small business owners make, along with some tips for avoiding them.
#1 Fail to distinguish between the entity and the individual. An owner of a business is not necessarily shielded from personal liability just because the owner formed a corporate entity for the business. All third parties should be made aware they are dealing with a separate entity and not an individual. Therefore, all business cards, letterhead, invoices, bids/proposals, contracts, websites, etc. should clearly designate the separate existence of the company, by using the complete name of the company.
#2 Ignore corporate formalities. Your corporate entity should have bylaws or an operating agreement that outlines the responsibilities of the owners and day-to-day operations of the entity. The bylaws or operating agreement generally contain provisions for: the structure of the entity, the duties, and responsibilities of shareholders, directors, officers, voting powers, allocation of profits and losses, management details, the fiduciary duties of shareholders, members, officers, and directors. In addition, the owners and directors of the corporate entity should hold a formal meeting at least one time per year. The meeting should cover (at a minimum) a review of the current operations, approval of any major purchases and/or loans and salaries or “draws,” goals or plans for the next year, and other issues affecting operation or governance of the entity.
#3 Forget to file annual reports. Each year, corporate entities must file annual reports as required with the state of organization and every state in which the company is authorized to do business. Your company may be administratively dissolved (meaning it’s no longer registered in the state of Wisconsin) if the annual report is not filed.
#4 Neglect succession planning. Many business owners neglect to establish a plan for the transition of the business in the event of the owner’s retirement, disability or death. If such events occur, then a well-organized succession plan dictates whether the business should be sold to employee(s), a third party buyer or transfer of the business to children. The failure to develop or implement a plan could lead to the closing of the business and/or reduction in value of the business. It is important for business owner to establish a plan to ensure continuation of their business to the next generation and achieve the maximum return on their investment.
#5 Fail to properly dissolve. When a business closes, the debts and obligations of the business need to be paid before any assets are distributed to the owners. Too often people will stop operating (and stop paying bills) and just keep the remaining assets. That’s not how it works. Business owners must liquidate assets, and then pay creditors and then assets remaining assets of the business are disbursed to the owners. Dissolving a business properly reduces the possibility that someone will try to make a claim in the future.
#6 Forgo written agreements. When providing services for customers or third parties always use a written contract or agreement. The days of handshakes being sufficient are long past. Written agreements and contracts document sets forth the terms/conditions of the services and help avoid disputes down the road.
#7 Fall behind on taxes. Whether for income, workers compensation or unemployment, taxes must be kept up to date in order to avoid interest and penalties. The easiest way to handle taxes is to hire a good accountant who can offer tax advice and consultation along with reminders if needed.
#8 Skip insurance. Even the most careful businesses need some insurance—if not for property then at least for liability. It only takes one person to slip and fall on your property to potentially close your business. Many companies now also need to worry about data breaches and auto insurance, too. An experienced business insurance agent can help you determine what you need to manage your risk and protect your investment.
By Brandon Prinsen, Partner, Johns, Flaherty & Collins, SC. For a La Crosse business lawyer, call him at 608-784-5678.