It is extremely important to understand why Corporations, Limited Liability Companies (LLCs), and Limited Partnerships (LPs) are used to conduct business. These entities are legal beings created and regulated by state laws. Therefore, these entities are legally separate from the individuals who own them.
To retain this separation between the individual owners and the entity, certain legal requirements and formalities regarding the maintenance and operation of the entity must be followed. If these requirements are not followed, the separation between the individuals and the entity may be disregarded—sometimes with disastrous consequences.
If certain legal formalities and requirements (discussed below) are not met, your Corporation, LLC, or LP could be disregarded as an entity separate from its owners or managers. The following is a brief summary of some of the consequences that could result:
Loss of Limited Liability: If you were to ask a randomly selected group of small business owners why they elected to do business using one of the above legal entities instead of operating as a sole proprietor or general partnership, the answer you are most likely to hear is that they want to protect their personal assets from the liabilities of the business. This is the number one reason business owners incorporate or organize an LLC or LP.
If you do not treat your business entity as separate from yourself, it is possible that the business entity will be disregarded at some time in the future by a court or government agency like the Internal Revenue Service. The result could be financially devastating. If the business entity could not pay its debts, whether from regular operations or from liability attaching as a result of lawsuit or government action, the personal assets of the owners would be made available to the creditors of the business entity.
Continual / Perpetual Existence: Because business entities are legally separate from their owners, the death or disability of the owner does not mean that the business is dissolved (in the case of death) or unable to conduct business (in the case of disability). Changes is ownership and management are specifically addressed in the by-laws of corporations, in the operating agreements of LLCs, and in the partnership agreements of LPs.
Access to Capital: A business entity is a more attractive vehicle for investors than a sole proprietorship. Private investors are able to invest in business entities with confidence. This confidence comes from being able to invest and receive either a debt obligation (which may be convertible into equity under certain circumstances) or a portion of the ownership of the entity.
Potential Tax Benefits: The owners of corporations and LLCs taxed as corporations may be able to receive tax benefits by sheltering business income in the entity—thus reducing the owners’ overall tax liability.
Commercial Credibility: American consumers are more accustomed to purchasing goods and services from businesses than sole proprietors. This instant reputability is another leading reason individuals use a legally separate entity as the business vehicle of choice.
Employee Benefits: Under certain circumstances, the ability to offer more comprehensive and deductible fringe benefits may result.
All too often, the requirements of just keeping a small business running leave little time for the owner or owners to engage in corporate/LLC/LP “housekeeping” and “maintenance.” Without some level of diligence on the part of the owners, a gradual merger of the life of the business and the life of one or more of the owners can begin. When this happens, the separate legal status of the business entity begins to fade.
If you have been neglecting the “housekeeping” and “maintenance” of your corporation, LLC, or LP, in all but the most extreme cases, the fix can be very simple. The following steps should be taken by all business entities, even those owned and managed by only one person.
As an initial matter, you should ensure that your business entity is in good standing with the Colorado Secretary of State. Even if your entity is delinquent in annual filings or other matters, it is usually very easy to bring your entity into compliance with the Secretary of State. Typically, this will involve the filing of a delinquent annual statement or, possibly, reinstating your entity if it has been deemed dormant or inactive. Once the Secretary of State’s office shows your entity to be in compliance and good standing, it is time to bring your internal entity governance up to date. This step can not be over emphasized in its importance. Being in good standing with the Secretary of State is only the initial step in having your business entity recognized as separate from you (as the owner) at some future time whether in court or by a government agency.
The very first action item is to ensure that your business document binder is up to date. (This binder is universally referred to as the “Corporate Book” irrespective of whether you own a corporation, LLC or LP.) The binder should contain your entity’s organizing documents (articles of incorporation or articles of organization), the operating documents (by-laws, operating agreement, or partnership agreement), evidence of ownership (stock certificates, membership certificates, or partnership certificates), transfer ledgers, resolutions and agreements to extraordinary actions (opening bank accounts, signing a lease, making tax decisions, appointing officers, etc.), minutes of each annual meeting, tax documents (such as the Request for Employer Identification Number on Form SS-4 [the tax identification number for domestic business entities], S-Corporation Election on Form 2585, Tax Returns on the applicable forms [1065, 1120, 1120-S, etc.]), required permits and licenses for your type of business, leases, loan documents, and any other documentation that is evidence of your respect for the separation of the business entity from yourself.
Once the business document binder is put together, the final step in bringing your entity back into compliance with legal requirements involves preparing for and holding a meeting of the owners and directors (or managers). If your business entity has never had a meeting, or if it has been a while since a meeting was called, the preparation will include drafting several documents to allow the entity to record and approve its past actions and plan for its future actions.
A small business attorney can assist you in all aspects of bringing you business up to date. An experienced small business attorney can do so in an extremely time effective manner. Before you hire an attorney to assist you with your small business, you should always find out how many business entities he or she has brought into existence and how many annual meetings he or she has prepared for and presided over.
If you have any questions, I will be happy to assist you in understanding the need for or preparation of:
