Blog | Entrepreneurship

7 Steps to Achieve Limited Liability

How to Protect Yourself and Your Business

Summary

• A good entity is one that shields your personal assets from business risk

• There are four different types of entities, be sure to pick the right one for your business

• Failing to follow these right steps could make you personally responsible for claims against your business

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There are many things that can go wrong when starting a business, including how you set up your entity.

As you’ll learn from Garrett Sutton, legal expert and Rich Dad advisor, the potential can be lethal.

Take for example, Garrett’s client, who was a plumber in the state of Nevada. He had been at it for five years and saw some real success during those years. While he was a good plumber (really good) legal matters like setting up his business weren’t his strong suit. Instead of consulting with a professional to set up his business, relied on his part-time bookkeeper for suggestions.

Knowing nothing about filing paperwork, or forming a corporation, the plumber’s bookkeeper suggested he operate as a sole proprietorship. After all, there’s little to no paperwork. So for this really good plumber (but terrible lawyer client), it seemed like the right thing to do.

Well, as you’ve probably guessed by now, things didn’t go so well for this plumber client. His business was sued following an incident involving an employee and a customer at the customer’s house. And because he was a sole proprietor, this meant that he, and not the business itself (as opposed to with a corporation) was sued and had to defend himself. This case went to trial in which a jury awarded the victim $10 million.

The plumber was wiped out. He lost his house, his savings and his family. In this case, had he set up a limited liability entity, this disastrous event could have been prevented.

What is a limited liability entity?

First, what does the word “entity” mean? It refers to an organization which has a legal identity separate from its members. It is a real thing, distinguishable and apart from its owners.

A good entity is one that shields and protects your personal assets from business risk. A bad entity is one that provides you no protection whatsoever. To review which ones provide limited liability read Garrett’s blog, Select the Best Entity for Your Personal Strategy which explains the good, the bad, and the ugly when it comes to setting up your entity.

There are four types of entities:

C Corporation-An entity of its own right, able to enter into contracts. This entity requires Articles of Incorporation filed with Secretary of State, along with bylaws.

S Corporation -A corporation that has elected flow-through tax status so taxes apply to individual shareholders. This entity also requires Articles of Incorporation filed with secretary of State; form 2553 filed with IRS, and bylaws.

Limited Liability Corporation -This entity may be treated like a traditional corporation or as a flow-through tax entity like an S corporation. This entity requires Articles of Incorporation filed with the Secretary of State (like the above), and while not required, an operating agreement is recommended.

Limited Partnership - A limited liability partnership with flow-through taxation. This entity requires LP-1 filed with state; and a partnership agreement is recommended (though not required).

Note: When you select your entity type, it’s not a one size fits all situation. Refer to an attorney or accountant for which entity best fits your business plan.

How to achieve limited liability

These following seven steps are important to follow to achieve limited liability. Failing to follow these seven steps could make you personally responsible for claims against your business.

1. Form a limited liability entity: Various entities are available and each provides different features and limitations. If you have a business that is not operated as a limited liability entity, your personal assets and all of the assets of the business may be in jeopardy.

2. Use a reliable resident agent: A resident agent is the person who receives service of process on your entity’s behalf. It does not cost a lot to follow this very important corporate formality.

3. Perform required annual filings: Annual reports must be filed and an annual fee paid to your state to achieve limited liability. Just as forming your entity and using a reliable resident agent is crucial to setting up your business, filing your annual returns is a must to maintain limited liability.

4. Prepare or have an advisor prepare minutes of meetings: Preparing minutes of meetings indicates that you are treating your entity as something distinct from yourself. They are a written record of your entity’s decision. This is something you can easily have someone do for you.

5. Put the world on notice: One more step to distinguishing you from your entity is by telling the world you are acting as a limited liability entity. On your business cards, brochures, contracts and checks you want to have Inc., LLC or LP displayed so people know they are dealing with an entity and not you personally.

6. Maintain a separate bank account: Another step to telling the world that you are acting as a limited liability entity is to distinguish your personal assets from the entity’s assets and maintain separate bank accounts.

7. Have an advisor prepare separate tax returns: Limited liability entities are separate tax entities, and require separate entity tax returns. Listing revenue or expenses on your personal tax return that belongs on the entity’s tax return is not a good idea. You should consider hiring a professional accountant to avoid problems.

You can avoid having the corporate veil pierced and protect your personal assets by following these important (but easily achievable) steps.

To learn more about protecting your business against claims, get Garrett’s book: Start Your Own Corporation: Why The Rich Own Their Own Companies And Everyone Else Works For Them.