Start the New Year Right by Doing Your Homework

As I have written in the past, there are three basic types of business formation that can conduct business in California: the sole proprietorship, the partnership, and the corporation.

A fourth type of business formation, "the limited liability company" (also known as an "LLC") is growing in popularity although it cannot obtain most types of business licenses.

As an example, the Contractor's State License Board will not license an LLC. Thus, it is not appropriate for most of our readers and we will not discuss it herein.

Generally speaking, the sole proprietorship is the simplest form of business, though it leaves no real protection for the owner's personal assets in the event that the business goes under or cannot pay its business debts.

A partnership is a manner of sharing a business among two or more persons or entities, but again, the personal assets of the partners could be at risk.

Lastly, a corporation is an entirely separate entity and is intended to shield the owners (better known as the shareholders) from personal liability for the debts of the corporation. However, that is not always the case as discussed in this article.

There are things you can and should do to protect yourself, regardless of the form of business you have. However, there truly is more to do to protect yourself if you are incorporated.

An individual or sole proprietorship should consider whether your business would be better served by incorporating. This is something you should discuss with both your lawyer and your accountant because there are tax issues with incorporation. In many cases, however, the corporation can be a shield to your personal liability.

As an individual, you should also make sure that all of your insurance policies are up to date and that you have the appropriate coverages for your business.

You may wish to discuss an umbrella policy with your broker. These types of policies generally provide coverage above and beyond the coverages that are provided on your homeowners‚ and business type policies, for a proportionally reduced premium. That is to say, the premium on a $1 million umbrella policy is often substantially less than the premium on a $300,000 homeowners‚ or business policy. This is usually because claims in excess of that amount are rare. It is also because the other policy may have the first obligation to defend and indemnify you before the umbrella policy kicks in.

Again, this is something you should discuss with your insurance broker. You may also want to consider and discuss how your business will continue if you are unable to continue its operation.

You should also evaluate the way you finance your operations. Many small businesses, especially with the lower interest rates that are available today, finance their business through home equity lines. The apparent problem with this is if your business goes under, you may lose your home. On the other hand, if you have a small business financed through bank loans, credit cards or merely accounts payable to your creditors and you can‚t pay your bills, you may go bankrupt, but you may be able to protect the loss of your home.

As far as partnerships are concerned (which sometimes are known as joint ventures, though there are some minor differences) you and your partner should make sure you have a good written partnership agreement. A partnership agreement is essential when things go wrong. More importantly, the partnership agreement may be important if something should happen to you or your partner(s), such as an illness or an untimely death. It is important to know that each partner can be liable for the acts of the other partner that are done in furtherance of the partnership. That means that if one partner goes out and buys a $10,0000 copy machine for the partnership, the partnership and possibly the other partner are liable for that debt. You should be clear as to each partner's role in the business and what they can and cannot do.

You may also wish to consider a buy-sell agreement in the event either partner wants to dissolve the partnership or in the event of the death of a partner. This is also a good idea for small closely held corporations. This will keep you from having to do business with someone you do not know. Some buy-sell agreement provide for a life insurance policy, paid for by the partnership, insuring the lives of each partner, such that if one of the partners were to pass away, the life insurance policy would pay that person's estate for the partner's share of the business. This is something to discuss with an insurance broker and an attorney.

If you are already incorporated, it is essential that you hold meetings of the directors and the shareholders at least once a year. You should maintain minutes of these meetings and keep them with your corporate documents.
One of the ways for a creditor to go through the corporation and seek the shareholders‚ assets is if the corporation did not maintain its "corporate formalities." However, even where the corporation has nevertheless maintained is formalities, there are circumstances where the officers or shareholders can be personally liable for the acts of the corporation.

Most people will not loan money to a small or relatively new corporation without some sort of personal guarantee. This is especially true for banks and financial institutions, but is just as common for material suppliers or wholesalers. An examination for most credit applications show that the person signing on behalf of the corporation may be personally liable if the corporation does not pay its bills.

The same is true for business credit cards. Almost always, the individual signing the application is going to be liable if the corporation does not pay its bills. This of course defeats one reason for incorporating.

As your corporation grows and its credit improves, you may want to consider finding new sources of material or credit where your personal assets are not at risk in the event of non-payment. If your corporate credit is good, you could attempt to renegotiate the terms of your credit agreements to remove any personal guarantees.

As to both the corporations and partnerships, you should make sure to maintain the proper insurance policies and that those policies name your primary officers or partners as additional insureds under the policy. This is because many times the individuals are sued at the same time as the partners in the event of a dispute or a claim. As to all business that are registered with the Secretary of State, including corporations and limited partnerships, you should make sure that your authorized agent for service of process is listed and is current, including the address for service.

The new year is a good time for all types of businesses to make sure you have the proper contact information, including a correct address, on file with any licensing bureaus or boards that govern your business. If they have the wrong address and you have not updated your information, they do not have to search for you. You could unknowingly have a problem and not have a defense merely because you did not notify them of your change of address.

In today's hectic and sometimes crazy times, most people concentrate on the operations of their business and don't think about the formalities and the administration of that business. When things go wrong with the business, it is maintaining those formalities that can protect you.

In the new year, now is a good time to do whatever is necessary to protect you, your business, and families.

Bruce Rudman can be reached at the law firm of Abdulaziz & Grossbart, P.O. Box 15458, North Hollywood, CA 91615-5458; (818) 760-2000; or by e-mail at bdr@aglaw.net. The presentation and/or documents are of a general nature and are intended to highlight areas of the subject matter and should not be used as a substitute for specific legal advice.