My accountant suggested that I turn my side-line business into a corporation. I’ve been selling stuff I get at thrift stores online and making a good living out of it. Sometimes I do some original sewing too by copying the fashions I see on Instagram. I’ve been depositing all checks into my personal bank account to make it easier for me to operate. Do I really need to set up a corporation?
There is a time in many part-time or freelancer’s life when they decide to get really serious about the business of business. No longer do they treat their money-making activities as a hobby or random adventure.
Your accountant is giving you good advice. Actually, I bet your accountant is giving you a warning too. Your longer letter indicated that you are doing quite well. That’s the good news. But you may also be treading on some large company’s trademarks, which could lead to some unwanted litigation and liability to you.
Yes, now is the time for you to no longer operate your business as a sole proprietorship. A lawyer can help you work through the details, but here are the highlights of the two most popular options for limiting your liability—a corporation or a Limited Liability Company.
Corporations are a form of business organization that can be set up by one person or a group of people. There are different types of corporations including professional corporations, standard or “C corporations” and “S corporations.” Each has varying administrative requirements and benefits for their founders and shareholders. You also have the option of forming a Limited Liability Company, but in many states the annual fees far exceed the costs of maintaining a corporation.
Perhaps the primary reason why business founders choose to incorporate a business is the opportunity to shield founders and corporate officers’ personal assets (homes, cars, savings accounts, etc.) from potential unpaid business debts, product or service liability litigation and other costly business calamities.
This nifty protection, often called the “corporate veil,” is especially important to older, second career entrepreneurs who tend to have more personal assets than younger entrepreneurs who are just starting to build their personal net worth.
Now here is the qualifier: The corporate veil remains in tact only if the corporation remains in “good standing” by meeting all of its corporate duties. If cranky banks, landlords, plaintiff attorneys, equipment leasing companies and suppliers are determined to find a way to collect unpaid bills, they will seek to pierce the corporate veil by convincing a judge that the corporation’s good standing was somehow compromised.
One of the easiest ways unpaid debtors can pierce the corporate veil is by proving that the corporation was not run as a separate entity from the founding entrepreneur or corporate officers.
Here are 6 action steps that every entrepreneur can do to safeguard their personal assets:
- Document loans and advances.
It’s never wise to pay any corporate bill directly from a personal checking account. If you have to use personal funds to pay growing business obligations, write the personal check to the corporation first and then immediately document the sum as a loan advance or new investment in the corporation. Equally, don’t abuse corporate expense accounts or borrow funds from a corporation without signing a loan document or filing expense reports and immediately reimbursing the corporation.
- Keep it separate.
Get a separate business credit card to manage business travel and other expenses. The credit card doesn’t have to be a so-called “professional” credit card with your company name on its face, just a separate credit card account.
- Use your corporate title.
Vendors and collection agents like to claim that they were misled by small business owners. They say they thought they were providing a product or service to a person rather than a corporation. To avoid confusion, write your corporate title and corporate name next to all documents that require your signature such as contracts, leases and business letters. This signifies that you are signing in your official capacity as an officer or employee of the corporation.
- Correct billing errors.
All debts, invoices, tax obligations and other business liabilities should be addressed to the corporation or amended before payment.
- Do what you said you would do.
At the time of incorporation, entrepreneurs outline certain administration obligations in the corporation’s charter and bylaws. If, for example, your incorporation documents state that the corporation will always have three to five board members, then maintain a board with three to five board members.
- File all tax returns and corporate annual reports on time.
Some states are more punitive than others with regard to incomplete documentation and tardy filings. Another requirement to help keep a corporation in good standing is to consistently advise the governing state of incorporation of any changes to the corporation’s business address, names of officers or directors, capitalization, articles of incorporation or bylaws.
I know all of this seems like a big hassle. But I bet as you organize your company in a professional way, you may be even more motivated to set ambitious goals for your company’s growth. And I hope one day in the future that I will see your original designs, influenced by your own creative inspirations, available for sale at retailers online and offline. Good luck to you!