Often the first thing I hear from a new business client is “I want to incorporate”. Many times that is what we end up doing. But usually what the client really wants is to start a new business and—the instincts are good here—to minimize personal liability.
Surprisingly often, after hearing the plans for a budding business, my best advice is that need capital can be better used for something other tna paying a lawyer to set up a corporation, at least at first.
Sometimes, after talking to the client and usually with his accountant, another form of business entity such as a limited liability company is recommended. But that is another discussion.
Everyone has heard scare stories about the high number of startup businesses that fail in the first few years, and no one wants to deplete their savings or retirement funds to pay debts of a failed business. But it should be kept in mind that the liability protection of a corporation or other limited liability alternatives is of no help when the owner or owners voluntarily guarantee loans of the business. And it is rare that a bank or other experienced lender will miss that one. Even a savvy trade creditor will often be unwilling to supply much in the way of equipment or inventory without a personal guaranty.
Getting back to the basic purpose of minimizing liability (and the new catchphrase is “asset protection”) my first advice to a new business is to buy as much liability insurance as is affordable. A small retail or service business that does not provide much risk to the customer can get by on fairly low commercial liability premiums and can save the costs of setting up and maintaining a corporation. It should not be forgotten that a corporation or limited liability company requires certain formalities in its operation, which means ongoing accounting advice and usually another set of tax returns every year.
However, if your business poses certain risks to customers and the public which cannot be affordably or fully insured, the initial and ongoing costs of setting up a corporation or other limited liability business entity are well worth it. Even for a less risky business, if the capital investment and amount of money expected to be handled by the company is substantial, costs of organizing and maintaining a corporate or similar structure are worthwhile on a relative basis. For a more complicated business, the built-in organizational structure provided by corporation laws and similar statutes are beneficial.
If the business will have more than one owner (perhaps excluding husband and wife), a corporate or similar structure is generally advised in order to provide a structure for sharing profits and losses as well as exit provisions.
As in every important business change, good communication among the business owner and an attorney and accountant familiar with the business can lead to the best decision.
-Dennis O’Toole
“Asset protection” is new business seminar catch word for concerns that have long been part of standard business law advice.
While the concept of asset protection dates from the origins of business corporations, there has been a recent expansion in the number of limited liability entities. The protections offered by these entities are, practically speaking, equivalent to those provided by a corporation.
The first inquiry in reviewing asset protection needs is the degree of risk involved in the business. It makes no sense to spend substantial dollars to protect against a minimal risk. Not only does a one-person consulting business pose less risk than a bar or chemical distribution business, but the protections of a corporation or other limited liability entity may well be illusory for the owner in many situations.
While legal limitation of liability generally protects a business owner’s personal assets from claims created by actions of a business’ employees, it is important to understand that the individual causing harm still has personal liability for the harm. Where the owner of abusiness is its sole employee, the costs of incorporating may confer little or no asset protection benefits. It should, however, be kept in mined that there may be other benefits to setting up a formal business entity. These benefits include ease of transferring ownership and access to statutory rules relating to operations.
An asset protection method perhaps even more fundamental than legal liability limitation is careful use of insurance. With new types of liability constantly arising (from asbestos to PCB’s to mold to ?) and with the insurance industry responding with new coverage exceptions, a program of asset protection involves much more than calling an insurance agent for a quote. The nature and known risks of each unique business must be reviewed with a business insurance agent to arrive at a comprehensive and economically feasible program of insurance coverage.
I have increasingly been called upon to advise clients on a less recognized asset protection issue – contractual risk shifting. I have seen more and more “boilerplate” contract terms which require one party to assume liability for problems created by the other party to the contract. Often this assumed liability is not covered by insurance. Too often this language is not discovered until a claim has been made. It is now more important then ever to read all contract terms and review them with a lawyer experienced in insurance and liability issues. Your lawyer will often involve your business insurance agent to help structure the deal so that assumed risk is covered by your insurance to the fullest extent possible.
A useful asset protection program will not result from attending an evening seminar conducted by a traveling asset protection “expert”. Effective asset protection can best be initiated by consulting with lawyers, insurance agents and other professionals the business owner deals with on a regular basis. It takes a long-term understanding of a client’s business for a professional to best advise the client as to asset protection.
A small business needs to analyze tax risk, liability risk and the risk imposed by onerous government regulation among other threats to profitability and growth. By establishing stable relationships with bankers, lawyers, accountants, insurance professionals and financial/business advisors, a small business owner can maximize protection of business and personal assets as well as free up time and capital to focus upon business success.
-Dennis O’Toole
Larger companies often have the luxury of hiring staff lawyers and other in-house professionals—accountants, finance directors, risk advisors. With professional advice available with a walk down the hall, looking at a new venture or analyzing a potential problem can be handled quickly and with a minimum of lost time. Unanticipated legal or tax consequences of a business decision are less of a threat.
Closely held businesses, especially startups, have to take care in using available cash to buy professional services on an hourly basis. Purchased advice is certainly not used economically when a lawyer or other professional has to use his time and your money just gathering information about your business and obtaining background facts. Economies of scale suggest that regular relationships with a business lawyer and other professionals can approach the comfort level of in-house professional staff.
Less experienced business owners may believe that "shopping" for legal and other professional services and spreading their business around will result in economy and build good will. There is also the misconception that professional services are a commodity best bought at the lowest unit price.
A lawyer, accountant or other professional is in a much better position to economically provide prompt and sound advice to a business client whose business structure, style and commonly encountered problems are already understood. Similarly, the business owner’s familiarity with the professional’s expertise and methods facilitates good communication and usually results in a more efficient and consistent delivery of results. This saves both time and money.
I suggest that establishing relationships with a business lawyer as well as with an accountant or other tax professional should be among the very first steps a startup business takes. Selection of a business structure and establishing a good accounting system is critical to moving any business forward. Understanding legal risks and financial needs puts the business in a position to select and work with business insurance professionals and lenders.
As a successful business must be driven by the bottom line, the lowest professional hourly rate is rarely the best buy. A cut-rate incorporation process, for instance, will not seem like such a bargain when it is belatedly discovered that another business entity is a better fit or that additional advice and documents are needed to make your business plan work. An experienced lawyer concentrating in common areas of business practice will not need to research every issue, but will be in a position to spend the purchased time resolving the client’s legal issues rather than educating the lawyer.
Don’t be afraid to ask for specifics from the professional as to his or her experience in the types of matters for which you will expect to need regular advice. A confident lawyer will not hesitate to make referrals to someone with other areas of expertise when doing so would be in the best interest of the client.
-Dennis O’Toole