One popular myth about personal liability protection is that once you incorporate your business, you can’t be held liable for your company’s debts. Here’s the truth: you only have personal liability protection as long as you maintain your corporation correctly. There are many ways in which business owners can lose their personal liability protection. This will help keep you from making costly mistakes that could ruin your personal finances.
What is Personal Liability Protection?
Personal liability protection means that you are not personally responsible for any debts or liabilities incurred by the corporation. If someone were to sue your business, they would be unable to come after your personal assets such as your house, car, or money.
Many business owners choose to incorporate because personal liability protection enables them to separate their business from themselves. While forming a corporation will provide personal liability protection, it will not maintain your protection on its own.
Failing to maintain your business properly can result in losing your protection. When this happens, courts will hold the owners of the business personally liable for the business’ debts. This is what’s called “piercing the corporate veil.”
Failing to Properly Separate Yourself From Your Business
Corporations are supposed to be legally separated from their owners. This means that there are certain practices a business owner must engage in to maintain that separation. Here are some mistakes business owners might make when it comes to separating themselves:
• Failing to maintain a separation between their business and the personal finances.
• Ignoring corporate formalities. This can include failing to record major corporate decisions in meeting minutes.
• Failing to comply with state regulations. This can include filing annual reports, having a valid registered agent, and making required payments to the state.
Fortunately, these mistakes are easy to avoid. Separating your personal and business finances is as easy as getting a separate bank account for your corporation. Also, when you are making important decisions for your business such as changing the name, deciding to hire employees, or changing pay structure, make sure you properly document it in your meeting minutes.
Engaging in Illegal or Fraudulent Behavior
If it is found that your business has engaged in actions that are illegal, fraudulent, or unethical, it could be grounds for piercing the corporate veil. This can include recklessly borrowing and losing money, entering into business deals with knowledge that your company couldn’t pay what was owed, or failing to pay your employees on time.
Failing to Ensure Adequate Funding
If a judge finds that you decided to operate your business without a reasonable amount of capital, it could be a reason to pierce the corporate veil. While mistakes are expected, it must be evident that you gained adequate funding for your business before choosing to operate it. There are multiple ways to raise capital: business loans, investors, and taking on new owners are the most common methods.
Incorporating your business is a great way to protect you and your family from potential liabilities that may arise when operating your business. It is essential that you do your due diligence as a business owner when it comes to maintaining your personal liability protection.
One of the best ways to do this is by having periodic “legal checkups” with your attorney to ensure that you are still in compliance with the law. By taking preventative measures, you can ensure that your personal assets are always safe.