A small business can be structured in a variety of ways. The most common entities are sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. A properly structured LLC or corporation can provide a liability “shield.” This means that the individual owner may be shielded from the debts or liabilities incurred by the operating business (and vice versa). Both the individual and the business entity will typically remain obligated for their respective debts/liabilities. Although liability protection is not absolute, it can be useful and valuable—there is a reason that most successful businesses are structured as some sort of limited liability entity.
Some new business owners want to wait and see whether the business “takes off” before they consider a formal business organization. Unfortunately, this approach has potential downsides: (i) the business may be impaired by a subsequently incurred personal liability; (ii) if the business succeeds, the legal structure, property ownership and contracts may need to be modified at a later date; and (iii) if the business struggles, the individual owner will often wish that the limited liability protection was in place so as to protect personal and family assets.
Many small business owners are unsure as to the legal structure of their business. We frequently hear the following: “The bank told me to file something with the Secretary of State – so I think I’m incorporated.” But this is often incorrect. Banks may only require the registration of a business name—which usually means you are operating as a sole proprietorship or partnership. And no one wants to find out that they do not have liability protection until after a lawsuit is filed.
Every business owner hopes to retire some day. But many fail to have an exit strategy when the time comes. Running a business does not have to be ‘till death do us part.’ You should start your exit planning on day one. The type of business you run and the corporate structure will help dictate how you can transition the business to someone else, whether your successor or an outside purchaser.
Forming an LLC or a corporation is an upfront expense. But it is an investment that should not be delayed.
Contact Lerma Grover Law if you are starting a business, if you want to modify your current business structure, or if you have questions about the legal status for your existing business.