An entity is legally recognized as being separate and distinct from its owners. For example: Limited liability companies (LLC), limited partnerships (LP) or corporations–as opposed to general partnerships or undocumented sole proprietorships. (Each legal entity is referred to as an “entity” for this post.) I am often confronted with the question of why business owners should form an entity for their business, and whether it is worth the trouble and cost. In almost all cases, it is clearly advisable to form an entity for a variety of reasons.
Liability Protection
While having an entity, such as an LLC, will not absolve the owner from liability from everything (the owner would still be liable for his own wrongful acts when acting for the entity, such as libel or slander) there is a great deal of protection that can be gained.
When structured and operated correctly, even if there is only one owner, the business entity will be recognized as a legal entity, separate and distinct from its owner/s. The business will have its own distinct assets and liabilities. When there is a liability, it is of the entity and not the owner–absent special circumstances (such as a personal guarantee or a veil-piercing claim alleging the entity was not run sufficiently to allow liability protection). This can be valuable if the business fails or an unexpected event occurs.
Asset Ownership
When you formally structure your business with an entity, you are able to title assets in the name of that entity. While this consideration may be minor at first, it leaves many doors open for the future. For instance, it will be much easier to bring a partner into a business that is up and running, with distinct books and records, and with assets and contracts in its name, than if all items are legally in the name of the original owner.
Managing for Multiple Owners
When more than one owner exists, or multiple people are participating in the success of the business, it makes sense to have an entity–to document and divide the profits, losses, and management control.
Accounting/Tax Planning
Having an entity separate from its owners formalizes the accounting relationship and allows for separate accounts and record keeping. This is key to running and monitoring a business.
Image of the Company to Customers and Suppliers
Forming a business entity gives your customers and suppliers the message that you are committed to your business and plan to be there for them. Many people think that someone running a business in his or her own name is not fully committed.
Protection from Judgment Creditors
When you form a legal entity, you get a possible layer of protection from judgment creditors. They may be able to seize assets of an unincorporated business, but they will have a harder time with an established entity. For instance, Section 18-703(e) of the Delaware Limited Liability Company Act provides that “No creditor of a member or of a member’s assignee shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.” Under Delaware law, a creditor can go after an owner’s interest in a limited liability company (LLC), but not after the assets of that LLC.
Identity Protection
The separate legal entity can file for and obtain its own Tax ID number. This prevents the owners from having to give out their Social Security Numbers (or similar) to business counterparties. Some business anonymity can be achieved if counterparties do not know who owns and controls the entity.
Should I Do This Alone?
While it is tempting to look at a form or copy and paste language in the documents that a friend used (to form a different company) years ago, bigger issues exist. Give serious consideration to the form or entity to be used, location of formation, and long-term plans which may impact the formation process.
Hire someone to help early in the process. The tax, accounting, and legal cost of making a bad decision, or having an unfortunate provision in the governing documents at the time of formation, can be many times greater than the cost of an expert’s help.
What has been your experience with forming an entity? What types of issues or problems have you faced? Please share your thoughts in the comments below.
Each case is unique. Past results do not guarantee future outcomes. This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. Each case is unique. Past results do not guarantee future outcomes. This article should not be treated as legal advice to any person or entity. FreeImages.com/photographer elemntz11.
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