Posted by on February 23, 2010

Is it a two-way mirror, or a one-way glass?

I recently met with a client who had formed an LLC a few years ago. On the advice of a colleague, he had purchased a “kit” to help him set things up. “You just fill in the blanks.” Easy enough. We met to discuss his need for some ownership changes, and to review what had been done as far as the formalities that help prevent “piercing the veil.”

Piercing the veil is an expression we used to refer to the process of getting past a legal entity (LLC, corporation, or partnership) to impose liability on the members, shareholders, or partners themselves. This occurs (loosely speaking) when the courts determine that the legal entity is perfunctory; that it is a sham put in place to shield the actions of the members without any real legally operating entity, or no real business purpose beyond that shield.

One way to sustain the liability protection of your entity is to closely observe the formalities of operation: make your filings, hold board meetings, keep formal minutes, etc. Most “incorporation kits” focus on these formalities. Some may seem silly (like holding a board meeting when you’re currently the only member), but they demonstrate that you are doing everything you can to run the business as an entity apart from you as a person.

Is that enough?

It’s generally enough to protect you personally from accruing the liabilities of the entity (subject to certain limitations, depending on the type of entity). But what about protecting the entity from your liability? The kits I’ve seen don’t address this issue.

Especially for closely-held or small family businesses, it’s important to consider the entity’s exposure to your personal liability. That exposure comes primarily through the fact that your interest in the business is a personal asset. If you’re in a car accident, say, and you’re sued for more than your insurance covers, they might try to sue for your interest in the company. Do you want an antagonistic stranger sitting on your board, perhaps even holding a controlling interest in your life’s work?

These sorts of scenarios can be avoided if you plan carefully. Your Operating Agreement can place significant restrictions on the transferability of your interest, especially in the case of an involuntary transfer. Sometimes, you want your business to be easily bought and sold, even publicly traded. But for a small business, especially a family business, you may wish to insure that you can manage the impact of outside “personalities” on the operation of the business. (Managing the insider personalities is a topic for another day!) You may not want your business partner’s soon-to-be-ex wife voting half of his shares, any more than you want that disgruntled creditor sitting on the board.

So, while a business-in-a-box may be a good enough answer some of the time, it’s often not a complete answer. And you can’t get to the right answer if you don’t even know what the questions are. What are you trying to accomplish in organizing your business? Does a partnership, an LLC, or a corporation make more sense? Would a sole proprietorship make as much sense (and be easier to manage)? What are the tax implications of your choice?

Even if you do start with a kit, it’s a good idea to have a lawyer review your objectives with you. Like most solo practitioners I know, I have a keen sensitivity for clients’ need to manage costs, and I’m happy to spell out what parts of a project they can do on their own to cut costs, to discuss the actions that create the greatest exposure, and what can be delayed or deferred.

We can’t discuss options if we’re not talking.

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