We’ve all seen advice from the Internet that looks far from credible. There are the questionable websites promising countless get rich quick schemes. Weight loss is as simple as a eating this, trying out this miracle drink, or purchasing the newest stair stepper. My personal favorite is Facebook advice from Joe Somebody who specializes in digital marketing commenting on which type of legal formation you need to build a solid foundation for your business.
Hopefully you have never taken legal advice from Facebook friends. If you have, we should probably connect sooner rather than later.
While you may be laughing, you would be surprised at how prevalent it is for successful entrepreneurs to build their business on a questionable legal foundation. When looking to safeguard your most important asset, a generic template with fill-in-the-blank slots is not going to cut it.
Despite how simplistic and common sense this statement sounds, I have countless corporation or LLC owners coming to me with their entire business legal foundation standing on a cheap downloadable template. Needless to say, once they need to rely on that legal foundation—either in the event of being sued or dissolving a business partnership—legal troubles threaten the entire business.
This turns a visit to a lawyer from the equivalent of a checkup to an emergency room visit.
I consistently clean up both corporate formations and LLC formations. Regardless of size of the business, legal and accounting are the most neglected areas of the business. While neither area will directly make you money, not having everything in order can be extremely costly down the road.
If you currently have or are creating an LLC or corporation with two or more non-married partners or owners and haven’t consulted a legal professional about your legal entity, it’s time for a checkup.
There are several events that trigger emergency room style visits to my office.
- Partner or owner looking to leave without a buy-sell agreement in place;
- The death or disability of one partner or owner;
- Business being sued;
- Audit by the IRS.
All of these events are out of your control. Additionally, having a strong business formation in place will not prevent any of these situations from occurring. What it does is create a game plan for each of the scenarios so that the business is protected.
To put these events into perspective, here are corresponding ramifications that you leave the business exposed to:
- Partner demanding their $200,000 value share of the business when the corporation doesn’t have the funds to cover the buyout;
- One owner passing away and half the company going to the spouse. Without life insurance in place to buy the spouse out, the remaining partner pays the spouse out of the profits or has a partner you did not bargain for;
- The fill-in-the-blank business formation doesn’t protect the business leaving the owners personally financially liable;
- The IRS disregards the entity eliminating tax write-offs.
Your legal footing and business formation put measures in to either protect against these scenarios or build in rules for how each situation will be handled. For example, a good buy-sell agreement will be designed to not allow an exiting partner to cripple the business. The IRS will not disregard a properly designed businesses entity.
Occasionally, I see owners who recognize they are leaving their business unprotected and come in for a checkup. While the circumstances creating the need for the visit are not as dire, it’s still a crucial step. After all, the goal is to prevent the aforementioned issues.
When working with corporations, here are some of the items I identify:
- Missing or incomplete corporate minutes;
- Problems with issued stock certificates;
- No buy-sell agreement in place.
Here are common oversights for LLCs:
- No operating agreement;
- No buy-sell agreement in place.
Cleaning Up a Formation Gone Wrong
As mentioned, it is much easier to clean up a formation prior to the business running into legal trouble. Businesses currently being sued or facing scrutiny from the IRS require intensive legal counsel tailored to the crisis at hand.
It’s the equivalent of trying to rebuild a house foundation in the middle of an earthquake.
If you seek legal counsel prior to an emergency, the situation will be far less intensive. While every business entity is unique and will require custom legal documents, here are some of the common actions I do to clean up the formation:
- Amend articles to address unauthorized stocks issued;
- Issue stock certificates;
- Amend by-laws and add necessary clauses unique to the business;
- Update meeting minutes;
- Build out buy-sell agreements designed to protect the best interest of the business.
Putting these legal components into a business that is currently running will not be a comfortable process. It is the formalizing of rules mid-game. The amount of discomfort will directly relate to how long you wait.
It’s better to work out details for a buy-sell agreement while you and your business partner are on good terms. Waiting until one of you wants to leave the company will not end well for you or the company.
Additionally, how confident are you that your personal finances are protected if the company were to be sued?