Hi there Startup Nation. I`ve been a podcast listener for several months now and thought I`d throw my knowledge into the ring in what I hope will be a regular series of concise posts that will seek to bring a little information your way.
For this post, I`m going to write a little about maintaining business formalities. Maintaining business formalities is important and its something that many business owners neglect. The owners of even the smallest business should make sure to take some basic steps to maintain the formalities of the business.
First, what do I mean when I say "business" or "corporate" formalities? Basically, maintaining formalities means keeping records and separating the business from the owner`s personal life. How is this done?
Keeping records means not only keeping records, but more importantly creating records. Businesses have no memory and no ability to tell people how they are structured and what has happened in the past. That`s where the owner or group of owners come into the picture. Among other things, owners should make it a point to have a meeting of the directors of the company a few times per year and of the shareholders at least once per year. The discussion topics of these meetings should be recorded and so should the decisions reached at these meetings. Owners should keep all of these minutes and resolutions in a book, organized by date. It`s also important to approve of major business decisions as they occur, and keeping track of those approvals in the same book.
Next, it is key that a business owner keep his or her business separate from his or her personal life. This requires that the business owner keep separate accounts for the business, enter contracts in the name of the business whenever possible, and allow business assets to remain business assets, and personal to remain personal. In addition, transfers of money and property in either directon (owner to business or business to owner) should be approved of if not in the normal course of business, and appropriate records should be kept to document any transfer.
It can sometimes seem unnecessary to go through all of these steps, especially when the business is small and there is only one owner with no employees and no storefront. There are two main reasons for doing all of this. First, if a business or person is examined by the IRS, a good way to prove that one is on the up and up (besides actually being on the up and up) is by shoveling documentation at the auditor. The more someone has documented, the more proof there is that what was documented actually occurred. This can be helpful in avoiding negative tax consequences.
In addition, maintaining business formalities can keep away the dreaded result of "piercing the corporate veil." Piercing occurs where a business is essentially one in the same, or the "alter ego" of the business owner. When this happens, a business entity loses its ability to shield its owners from personal liability. This can be disastrous, since usually the main point of obtaining and doing business with an entity is to limit the owner`s personal liability. The more a business owner keeps up with maintaining formalities, the more likely it will be that a court would not "pierce" the entity veil, thus saving the owner from personal liability.
This is just a very brief overview of this area, but it`s importance cannot be overstated. It is also key to have documentation and records in case your exit strategy includes selling the business one day. Any possible buyer would no doubt want to see every shred of paper in a due diligence period, and might get scared off if there is none, or if the records are inadequate.
In addition, if you`d like to contact me regarding any of this, my contact information is available here on my Startup Nation profile.
Clint A. Costa, Esq., CPA (Licensed in Illinois only)