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When his father passed away several years ago, George became the principal of his father's small flooring business. George learned everything about the business from his old man, and he hasn't changed the way the business is run. With all the new construction in town, George was able to hire six nonfamily employees to work for him—guys he trusts to do the jobs while he takes care of the paperwork. Last month, one of those guys accidentally hit someone while driving the company truck. George's business wasn't incorporated, and it didn't have enough money to cover the cost of damages awarded to the injured person by the court, so the victim was also able to gain access to George's personal assets, including the money he was saving for his kid's college tuition.
George could have protected his assets if he had incorporated his business. The small-business attorneys I know like to say, "Incorporate early and often," which is exactly what I expect them to say. My opinion is a little different. First, let's understand what incorporating does for you. Simply put, by incorporating you:
1) Create a legal entity through which you do business.
2) Establish what is known as a "corporate veil," which protects the owner's personal estate from any claims made against the corporation.
This corporate veil is pretty handy. If an employee injures someone or something while working for you, any claim would likely be filed against that individual and your company, but not against you personally, unless you were found to have personally contributed to the accident.
But incorporation does have its limitations. If you are the only employee of your company, the negligent employee is you. So the liability insulation isn't going to protect you in this case.
You probably should incorporate. But initially, unless you start out with contracts, employees, vehicles, equipment, etc., you might be able to spend that $500 to $1,000 on something more critical, like a computer or a new edger.
This is where some lawyers would say, "Fine, Jim, but once you are up and running, growing and hiring people, you might forget to incorporate." They're right. So how do I solve this problem? With triggers. Here are some for you to consider.
You should incorporate when:
1) You hire your first employee, especially when that employee conducts work with any degree of danger, and/or work that is off your premises, as in a delivery or flooring installation. Example: If your employee causes an accident in one of your vehicles, any claim for damages would be against that individual and his employer (your corporation), not the shareholder of that corporation (you).
2) You enter into contracts on behalf of the business. Example: A customer feels that your company's performance has not met the contract provisions and decides to take legal action. If you are incorporated, any claim would typically be against your company, not you personally.
3) You make purchases from vendors on an open-account basis, which is to say they extend credit to your company. Example: If your company has difficulty paying vendors, as long as you have not endorsed a personal guaranty to a vendor, any action they might take will be against your corporation, not your personal estate.
4) You can afford $500 to $1,000 to spend on an attorney to become incorporated. But sometimes you can't afford not to be incorporated.
There is nothing wrong with being incorporated. My position is one of priorities.
There is at least one danger in being incorporated. Actually, it's not so much about being incorporated as it is about how you do business and manage your corporation. Here are a few of the mistakes you can make after you incorporate and while you are assuming what might prove to be a false sense of liability security:
• You don't tell anyone, like the people you do business with, that you are incorporated.
• You don't put "Corp.," "Corporation" or "Inc." everywhere your company name is shown.
• If you are part of a holding company, like a DBA (Doing Business As), and don't put "a division of," or "DBA" on everything.
• You don't have a checking account in the corporation's name.
• You don't maintain proper corporate documentation, such as corporate minutes and documentation of shareholders and directors meetings, failing to issue shares of stock, etc.
If you are guilty of any of these mistakes, you are at risk of having something happen to you called "piercing the corporate veil." (Sounds painful, doesn't it?) This is when someone brings a claim against your company, and they want to get to your personal assets. Their attorneys will actually look into how you conduct your business. If they can determine that you are guilty of some of the things I mentioned, (there are many other examples), they will attempt to demonstrate to the court that you are not operating as a real corporation, and therefore, not entitled to the liability protection of a corporation. If successful with this strategy, they can literally "pierce your corporate veil" and get to you and your assets. This is not an easy thing to do, unless you help them.
Write this on a rock ... If you can afford it, and if the time is right, incorporate. Absolutely. But when you do, make sure you operate like a corporation, not like the sole proprietor you used to be. Think of your corporate veil as you do your roof: maintaining both will protect you from dangerous things that fall from the sky—like hail and lawyers.