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Incorporating Your Business Has Surprise Benefit

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fence-145622_1280_optIncorporate to protect yourself from the debts of your  business, shriek the ads.

That’s the theory of incorporation:  create a separate legal entity in the form of the corporation.

Let that entity incur debt and expose itself to other risks.  If it fails, the personal holdings of the owners of the corporation are safe.

But, in the real world, most big ticket debts that a corporation might incur require the guarantee of the owner.

So if both corporation and owner are liable for the business debts, what has incorporation gained you?

You’ll be surprised.

Incorporate to protect the business

Consider the same move, incorporation,  for the opposite reason.

Incorporate to protect the business from the owner’s debts.

A sole proprietor and his business are one and the same in the law.

When the proprietor has a tax problem or there’s a judgment outstanding against him, all of the business cash and assets are exposed to that debt.

The business bank account can be levied for the owner’s back child support or a judgment against the owner for unpaid magazine subscriptions.

Most exemption laws found in state statutes protect some part of a wage earners salary.  The working man needs some part of his paycheck to put food on the table and gas in the car.

But a proprietor isn’t an employee of his business:  he and the business are one.

The debts of the businessman can put his business out of business.

Corporation immune to shareholder debts

It’s a different story if the business is owned and run by a corporation.

The corporation is a legal entity separate from the shareholder.  The shareholder’s creditors can’t take the corporation’s money to satisfy the owner’s debts.

As a shareholder, you don’t have to worry that your personal creditors will garnish the business’s account debtors to collect a personal debt.

The corporation can retain a reserve for its operation without regard to the claims of the shareholder’s creditors.

Get a job

Incorporating the business also allows the business owner to create a distinction between the money necessary to run the business and the money necessary to feed his family.   He can pay himself a salary, and leave the balance of the business assets in the corporation.

His salary is exposed to his debts, but not his livelihood.

State law provides exemptions that protect a portion of the wage earner’s salary from creditors, a protection that a sole proprietor doesn’t get.

So a creditor of the shareholder-employee can garnish the shareholder’s wages, but they only get a fraction of the total paycheck.  Exemption laws protect the balance of the earnings.

Knowledge workers and service businesses incorporate too

It’s not just brick and mortar businesses that can use protection from its owners.

Realtor and consultants who are not incorporated expose their business cash flow to their creditors.

Nothing is quite so devastating as having your clients served with legal process requiring them to pay the sheriff on your debts rather than paying you.  Or close a big transaction as a realtor and have the tax authorities levy your entire commission.

Incorporation is a powerful tool.  Its principal benefit is, however,  just the opposite of the conventional thinking.

Image courtesy of Wikimedia.

What Small Business Needs From Government

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business challenges

 

This post was first published 10 years ago, in the midst of the Great Recession.  I continue to think about the real challenges of running a small business and the balance needed between simplicity for the business owner and protections for the public.  More below.

Senator McCain this morning on Meet the Press reprised the Republican view of the approach to stimulus:  tax cuts for small businesses.

I thought about the small businesses I had seen in the past couple of weeks.  Not one of them was paying income taxes, and their expenditure on payroll taxes was small, because they’d cut back on  employees.

For the very small business, I don’t see taxes as the culprit.

Everywhere you look you see the impact of credit cards on the economy.  Often it’s suit by American Express that brings a small business owner to my office.

Or the businessman makes a list of their credit card debt and the interest rates after the recent round of increases and realize that they can never pay off the debt at 28% interest.

Credit card merchant fees are a much bigger piece of the small business expense picture than are taxes for most of my clients.  Each merchant pays a percentage of each credit transaction to the card issuer.   7-Eleven store owners are petitioning  Congress for regulation of the fees charged merchants  by the card issuers .

I’m certainly not an economist and don’t have a Moran Plan for reinvigorating the economy, but the people I see in trouble aren’t there because of their tax burden.

Small business wish list

Ten years later, my wish list for entrepreneurs is greater simplicity on the administrative side of the business.

Perhaps fewer jurisdictions to deal with and regulations that the average Joe can understand and follow.  Less need for hired professionals to keep the business out of trouble.

Looking around in 2019, the regulatory changes we’re seeing don’t seem to be helping Mom and Pop businesses.

More

Pitfalls to avoid for small business

Your money needs a prenup

Myth of the business credit card

How To Write A Contract Without A Lawyer & Make It Stick

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meeting-handshake-pixabay_optEven in a world where people attempt almost any skilled task with the help of Google, YouTube, or Legal Zoom,  people continue to ask: is this contract legal?

They aren’t asking (usually) whether the subject matter of the contract is permitted by law.

They really want to know: will what I’ve written be enforceable.

What makes it a contract

There are no magic words or phrases that make a contract enforceable by a court.

Enforceability is not acquired by adding “whereas” or “notwithstanding“.

A contract need only establish that one party made a promise to the other for consideration. Consideration is legalese for money.  Or something else of value.

If I promise to join you for dinner next Friday, we have not created an enforceable contract, because there was no valuable consideration exchanged.  My promise was gratuitious.  You didn’t offer me anything but your good company over a meal.

If , on the other hand, I promise to speak at the event you’re planning, for which you’ll pay my  fee, then we have an enforceable contract.  I will appear and speak, and you will pay.

If either of us fails to do what we’ve promised, a court will attempt to give the injured party the benefit of the bargain.

So here are four tips on drafting a contract that does the job.

Contract1.  Write out the entire deal

The biggest failing of DIY contracts is incompleteness.  They don’t describe fully the performance that is promised.  They miss one of the essential terms:

  • who
  • what
  • where
  • when

If you hope that a judge will enforce a contract, it has to be written such that an absolute stranger to the deal, the judge, can read the contract and know what was agreed.

Too many self-drafted contracts don’t contain enough for a stranger to understand the deal.

Now, contracts with missing terms or ambiguities can be enforced.  The contract is still “legal”.  It’s just that there is a great risk that the missing terms as the judge fills them in don’t match the intent of the parties.

Enforcement of a fragmentary contract is far more expensive than had the contract been complete.

Enforcement of the unwritten terms becomes victim to what each party remembers but didn’t write down.

2. Flush out & write down assumptions

Often, the contracting parties each come to the table with a collection of assumptions about the arrangement.  And each party assumes that the other party shares their assumptions.

Only, until you articulate your assumptions, you can’t test whether you are both, really, on the same track.

The unwritten assumptions form part of the deal.  A good contract lays the assumption out on paper.  If they aren’t shared when you sit down to write the contract,  discussion or negotiation ensues.

The exercise of writing it out becomes as important as the writing itself.

3.  Explore the “what ifs”

Well crafted contracts provide for the rights of the parties if things don’t go just as hoped when the contract was formed.

What if

  • one party gets sick and performance is delayed
  • the materials aren’t available on schedule
  • the product doesn’t perform as anticipated

My rule of thumb is that the more money that is involved, or the more critical the contract is to your business, the more what ifs the contract should address.

If the consideration is $1000, it’s not worth extended negotiating or drafting to deal with remote possibilities.  If it’s a $100,000, it’s worth more to lay out the details.

4.  Provide for attorney’s fees

If you expect to enforce the contract in court if it’s breached, then your contract should provide that the injured party can collect its attorneys fees from the other in addition to any other damages.

Why?

Because the American Rule about attorneys fees says that each party pays their own attorney, win or lose.  That is, unless the contract, or a statute, says differently.

Without a provision that grants the prevailing party the attorneys fees necessary to enforce the contract, it may simply be too expensive to go to court.  Or, the cost of representation may consume the damage award.

Write on

With these principles in mind, you can draft a contract that is certain and enforceable.  Strive for clarity and completeness.

And if this seem too daunting, take your draft to an attorney and pay only for review and repair of your document.

Because, at the end of the day, a contract only works if you can enforce it.

More

How you sign your name to your corporation’s contract

Benefits of incorporating not what you think

Does your business partnership have a prenup?

Image courtesy of Pixabay and Nemo.

Sign Your Corporation’s Name So You Aren’t On The Hook

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John_Hancock_Signature-wikimedia-public-domain

John Hancock knew how to sign his name- so large that King George could read it without his glasses.

But most small business folks who do business as a corporation are clueless when it comes to signing contracts on behalf of their corporation.

When they sign their name, without more, on the line that says “Owner”, they may have made themselves personally liable for the obligations in the contract.

Signing just your name likely defeats the very reason that you incorporated your business.  You’ve just put yourself personally on the hook.Fish-hook-green background-wikimedia-cropped

Why your business is a corporation

In the law, a corporation is a legal person, separate from the individuals or other entities who own its stock.  Despite how invested, financially and emotionally,  you are in your business, you and the business are really two separate entities.

The invention of the corporation made it possible for business people to limit their risk in an incorporated business to the amount they paid for their stock.  The creditors of the corporation couldn’t collect their claims from the stock holder.

That ability to limit your risk, to keep your business creditors away from your personal assets, probably figured large in your decision to incorporate.

How a corporation gets things done

Because a corporation is a “person” without any fleshy substance, it needs people to act for it.

Those people are its employees, managers, or its officers.  They can wield a pen and sign for the corporation.

A signature on a contract serves as proof that the signatories take on the benefits and burdens described in the written documents.  Physically, a real, live person has to sign.

But how do you sign for the corporation?

Acting for the corporation

Let’s assume that the document in question is an order for the design of a new website for your business and a year’s worth of maintenance.

You are the stockholder, president, and the manager of  My Business, Inc.  (For most of us small business folks, we are also the secretary, janitor, bookkeeper for the business as well.)

If this deal goes south, you don’t want the service provider suing you, liening your house, and garnishing your wages.  This is a corporate deal.

So, here’s how you sign the contract on behalf of your corporation:

MY BUSINESS, INC.

___________________

By  Your Name, President

You sign your name as you always do, but in your capacity as an agent of the corporation.  

Contracts don’t have to be signed by the president.  They can be signed by any party the corporation has authorized to act for it.  You could be, just as legally, the vice president, the CFO, or the general manager.

By adding your role in the corporation, you have signaled that the party to the agreement is the corporation, not you personally.  The entity making the promise to pay is the corporation, My Business, Inc.

Your signature as a representative of the corporation doesn’t put you personally on the hook for payment.

Good work, Mr. President!

More

Write a contract without a lawyer

Essential habits for entrepreneurs

Myth of the corporate credit card

 

Fish hook image:  © johnsroad7

Silicon Valley Horror Story: The Business Credit Card That Bit

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I’ve long said that there is no credit card for which a real, live human being isn’t liable.

(That may be an exaggeration, but not by much.)

And I’ve long worried about the prospects for success of business startups financed on credit cards.

But I’ve never seen a departing employee of a start up stuck with the bill for charges made by management after he left, until now.

He thought the card (and the balance owed) belonged to the business and he left it behind when he took a new job.

Eighty thousand dollars in charges later, he found he was on the hook as far as the card issuer was concerned.

It was a Silicon Valley horror story.

So, let’s review how this happened and what to learn from it.  Because this won’t be the last time that departing employees have gone out on a financial limb for a new venture that fails.

Who’s liable for the business card

While the card issuer may be willing to emboss the business name on the card along with yours, dollars to doughnuts, YOU are the only one legally liable to pay the bill.

Unless the card application calls for the signature of an officer of the business entity, the bank is extending credit to an individual who signs the application.

How a corporation signs its name

The business name on the plastic may make you look more “professional” or make it easier to sort business from personal expenses, but the legal liability lies with the named individual.

How management got free money

In a world of on line purchasing, possession of the card was probably sufficient to let the remaining employee charge more stuff.  When was the last time a signature was required for online use?

Maybe, the remaining employee genuinely thought the card was business property.

Or maybe not, given the nature of the purchases.

But my client left the card behind, without thought, until the collectors came calling.

Your exit strategy

Cutting ties to an employer should henceforth include cutting up the credit card.  Or more specifically, calling (and writing) the card issuer, closing the account.

Close the account, too, if the rupture is marital; don’t let more debt accrue

Closing the account doesn’t eliminate your liability for any outstanding balance, but it does prevent further use of the card.

And if the shoe is on the other foot, and you are the remaining employee and your company is actually liable on the account, close it when the named employee leaves.

 

 

 

 

5 Small Business Mistakes That Thwart Success

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small business

In recognition of National Small Business Week, we look at what a bankruptcy lawyer knows about business.

Everyone tells you what to do to succeed in business;  you also need to know what not to do if you don’t want to fail.

Running your own business is the classic American dream.  It’s romantic and heroic.

The romance of self determination, market recognition, and profit obscures the fact that the overwhelming percentage of small businesses fail within 5 years.

I love entrepreneurs.  They are creative, determined, skillful, and incredibly  hard working.  And still they fail.

Those failures represent not only dashed dreams, but financial pain.  That financial pain is personal pain as well.

No isolating business debt from personal assets

In thirty nine years as a bankruptcy lawyer, I’ve found themes in why they failed.  Here is my list of five behaviors tied to business failures.

They plan only for success

The business plan assumes steady straightline movement toward growth and profit.  A typical plan may start small and project growth.  But it doesn’t plan for setbacks.

  • What if it takes twice as long to get a toehold in your market?
  • What if capital costs more than you think?
  • What if your pricing model  craters?

Before you take the self employment plunge, you need to assess your ability to survive if your rosy plan for success is off by 25%.

The entrepreneur loves the craft, but not the business

If you’re a great carpenter, a great cook, or a great lawyer as an employee, it’s tempting to set out to ply those skills for your own benefit.  Run your own business, the way you think it should be run, and make more money doing what you do well.

When you go into business, you wear two hats:  the skilled professional AND the business manager.

Many business failures are grounded in the entrepreneur spending all his time on the craft, and less than the bare minimum on management.

Employment laws are ignored, bank accounts aren’t balanced, taxes are postponed.

To be a success in business, you need to attend to business, or to partner with someone who loves the business side of things.

They pay too much for existing business

Buying an existing business seems like the answer to all the start up difficulties.  It’s a turn key operation, often coming with some transitional help from the seller.

And, all too often, too good to be true.

The first question to ask is why the business is for sale.

Frequently, it’s because it isn’t really making it.  It may be paying the expenses of operation, but it isn’t actually supporting the owner who works there.  The hours are too long, the challenges larger than the rewards, and the owner wants out.

Ask yourself, why you want in under those circumstances?

Ask, too: are the books up to date?  Reliable?

Another motivation for sale is that the sellers want to retire and they see the business as their retirement plan.  To substitute for retirement savings, the selling price needs to be generous.

Is the business priced at what the sellers need, or what the business as constituted is worth?

No profit if financed on credit cards

Credit cards are associated with consumers and household budgets.  But all too often, new businesses are started on the owner’s credit cards.

The myth of the business credit card

Plastic is pitched to small business owners as either a convenience, a status item, or the bedrock of business operations.

It’s really hard to make a profit if your seed capital requires interest payments at 22%.

Also, far from simplifying business bookkeeping, credit cards obscure the fact that the debt service you pay on the credit card this month is really paying for a fraction of last month’s costs of operation.

Credit card payments become their own line item in the budget rather than simply a means of paying for inventory or services required last month.

They gamble their retirement on business success

When your retirement account  is the only hoard of money you’ve set aside and you want to go into business, the temptation to draw on your retirement to make it happen is almost irresistible.

You tell yourself you are making an investment in your future.

When you do that, you break one of the basic rules of investing:  diversification.  You have put all of your retirement “eggs” in the business basket.

If the business fails, you have neither a livelihood nor a nest egg for old age.

The phenomenon is not confined to those just starting in business.  Too many folks in my bankruptcy office to deal with a dying business tell me that the business was their retirement plan.

Instead of setting aside earnings for retirement, they plowed their money back into the business.

They expected to sell it to retire.

And now there’s nothing to sell.

Make a better business plan

Give some thought to the  business side of your craft.  Make a plan and go for it.  You can be great.

More

How to sign the corporation’s name to business deals

Your business needs a prenup

Essential  habits for successful entrepreneurship

Image: Pixabay

Know who you are when the business files bankruptcy

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While knowing who you are may be central to philosophy and mental health, you wouldn’t think it poses a difficult question in a business bankruptcy.

You wouldn’t think the word “you” would be so challenging.

Yet, small business owners find it hard to separate themselves from the business, even when that business is incorporated.

After all, the owner’s financial livelihood rises and falls with the success of the corporation’s business.

You and your corporate business

Twice in the past two days, I had occasion to point out to clients who own small corporations that when the bankruptcy trustee says “you”, the trustee is talking about you, the individual, not the business that you have been immersed in.

How to sign for your corporation and not be personally on the hook

But the distinction is important.

In the law, the corporation that owns the business is a separate legal “person” from the flesh and blood human being who owns the stock in the corporation and serves as its officer and director.

The debts of the corporation are not necessarily the debts of the shareholder. The corporation can file bankruptcy without the shareholder, and conversely, the shareholder can file bankruptcy without impacting the day to day operations of the corporation.

In analyzing a bankruptcy filing or answering questions from a bankruptcy lawyer or bankruptcy trustee, make sure you know who you are.

More about struggling businesses

Individual bankruptcy and business debts

Is it safe to file corporate bankruptcy

The unexpected benefits of incorporating

When your business needs to wind down

 

More on business bankruptcy on Bankruptcy in Brief.

Three Cheers For Entrepreneurs

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Entrepreneurs

Let’s hear it for entrepreneurs.  Those brave, tireless people with a dream who start or run small businesses.

They possess more energy and perseverance than most of us.  They form the backbone of our economy.

In honor of National Entrepreneurs Day, November 20th, let’s recap Soapbox’s best on being in business for yourself.

It’s probably not surprising that I like entrepreneurs, because I’m  an entrepreneur too.  I opened up my general law practice the day after I was admitted to the California bar.

Over the years, the focus of my law practice has narrowed as I’ve become an insolvency specialist, but I have always worked for myself.

So, small business folk are some of my favorite clients.

Clients I tend to see in my professional role when business struggles.  Here’s what I’ve learned about small businesses and the hardy folk who run them.

business divorceYour business needs a prenup

Anytime you pool your money with someone else, you need a written agreement about how you unwind the joint venture.  Just like marriage, business life changes and today’s partnership may not work at some point in the future.

 

small businessFive mistakes to avoid for success in your business

Culled from my four decades of advising business people, these five things stand out as reasons businesses don’t succeed.  Here’s what NOT to do if you want your business to survive and thrive.

 

incorporation protectsYou’re incorporating for the wrong reason

The best reason to incorporate your business isn’t to protect yourself from the debts of the corporation.  It’s just the opposite: incorporate to protect the business from your debts.

 

How to avoid being on the hook for business debts

You incorporate to limit you exposure to debts of the business.  Don’t throw the benefits of incorporation away by the way you sign corporate contracts.

 

Four essential habits for successful entrepreneurship

Here are four unsexy, but absolutely essential, habits to cultivate in business.  Adopt them from the start of your business:  well begun is half done.

 

Alternatives when the business struggles

closing businessThe hardest choice facing an entrepreneur involves failing.  Take a look at the alternatives available when it seems the business has no future.

 

Here’s hoping we never meet professionally.  Savor National Entrepreneur Day.

 

 

Your Business Partnership Needs A Prenup

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Wedding_2Financial partnerships are at least as challenging as marriages.  And business deals don’t have love to smooth the rough spots in the relationship.

The traditional marriage service ends with the charge that what God has joined together,  let no man put asunder.

That’s great with love, but not so great with money.

Something will likely asunder the business venture.

Yet people pool their money in business, real estate, and investments without a thought to how the partnership will end.

Chances are, it will end, and that end can be very messy and miserably expensive.

My charge to those pairing up for an investment is this:

At the start of any venture involving pooling money, lay out some rules for how you part in the end.

Think of your business wind-up rules as a prenuptial agreement for your business. [Read more…]

How Your Property Gets Sold In Your Partner’s Bankruptcy

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co owned property

It isn’t just marriage that can get you roped in to a bankruptcy case that isn’t your own.

Own community property and a bankruptcy filing by your spouse or your soon-to-be ex can drag you into a bankruptcy court.

But the issue is broader:  joint ownership of any kind of asset in any state, community property or not,  exposes you to a loss of control of your property if your co owner files bankruptcy.

The bankruptcy court has the power to force the sale your property or require you to buy out your co owner.  On a timeline not of your choosing.

Co owners at risk

If your partner in a business or a piece of real property files bankruptcy, the partner’s interest may be sold for the benefit of your partner’s creditors.

Oops!

And since the sale price of just your partner’s interest in the property would probably be less than the fraction of the partner’s ownership, the Bankruptcy Code gives the bankruptcy trustee the power to sell your interest too. [Read more…]

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