You’ve read the blog posts about how you need to form a business entity to protect you from personal liability for your business. So, you decide to form a Limited Liability Company (LLC)—in your home state or in a state like Delaware or Nevada—because those seem simpler than all the requirements of having a corporation, such as board meetings and minute-taking.
All too often, my new clients have done just that—formed a LLC—and that’s it. It’s as if that piece of paper from their state Secretary of State will shield them from potential liabilities.
The problem is, that piece of paper doesn’t do much by itself.
Yep, it’s true there may not be many formal requirements under state LLC law. But if you get sued (probably both your business and you personally), you will want a paper trail making it undebatable that the LLC is a legit business, separate from your person, and it should be liable for its own debts and obligations.
Here are 7 things you need to do to honor the separate entity of your Limited Liability Company, so it actually protects you from liability if you get sued.
1. Create an Operating Agreement and Enact Resolutions.
Even if you are a one-person-owner LLC, you should keep some formalities to show that you don’t just treat this LLC as an extension of yourself. The LLC should formally give you the power to sign contracts, open a bank account, take on debt, and do the other regular actions of the LLC. If the LLC is going to take an action that’s unusual, such as a large loan or a significant change to the line of business, a special resolution should also be enacted.
2. Change Your Bank Account and Merchant Account to the LLC.
If you started your business as a sole proprietorship, it is tempting to keep your business checking account, merchant account, and PayPal under the old name. But if you keep transacting business (aka taking money) as the sole proprietor, then really the LLC isn’t conducting this business at all. In some cases, you can just transfer ownership of the bank accounts, but some banks require you to open an entirely different kind of business account for a LLC.
3. Keep Separate & Adequate Books.
Bookkeeping does not need to be complicated. For some businesses, Quickbooks is overkill—there is nothing wrong with keeping the books of a simple business in a Excel or handwritten spreadsheet. If your LLC is taxed as a sole proprietor, one simple solution is GoDaddy Bookkeeping, which is a free/low-cost online system that understands how to automatically parse PayPal transactions correctly.
4. Sign Contracts on Behalf of the LLC, Including Leases, Loans, and SAAS.
Another common mistake is to keep signing contracts in the business owner’s own name. Once you form a LLC, you will want to sign the contracts “for” or “on behalf” of the LLC, just as if you were signing contracts for another person. Make sure to go back and change as many contracts as possible, including online software services, like your mass email host and your project management program
5. Adequately Capitalize the LLC.
Every business should be “adequately capitalized,” which means that the owners and investors should put in enough cash to get the business off the ground and to keep it running. For some simple, online/virtual businesses, this could be a minimal amount, such as $100. For businesses requiring inventory or racks of servers, this may be a significant investment. Either way, as the owner you should make some start-up contribution and track it in your bookkeeping system.
6. Track Owner Contributions, Distributions, Loans, and Reimbursements.
If you are the only owner, it is tempting to just take money out when you need money, and put money into your business whenever the business needs money. But this kind of casual accounting doesn’t help you when you want to show that this LLC isn’t just your alter ego. Pay yourself on a regular schedule (even if you can’t yet pay yourself regular amounts). If you are giving the LLC a loan, make sure to enact a written resolution and document the flow of cash and payment of interest.
7. File Annual Statements and Tax Forms.
Most states require LLCs to file an annual or biannual statement. This statement is usually a simple form, filed online, that confirms the names and addresses of the owners. In some states, you may also need pay for a state business license or file a state franchise fee tax return. Make sure that you follow whatever annual or biannual requirements are specified in your state, so your LLC doesn’t accidentally lapse.
- Get business liability and/or professional liability insurance. It’s all nice and good to have the LLC be liable, but that doesn’t help you when a lawsuit drives your LLC into bankruptcy. The biggest reason to have insurance is not to pay off the other side—it’s to pay for the lawyer to defend you in the lawsuit. Most businesses needs liability insurance for general claims (like a client’s slip-and-fall), and many professionally licensed businesses need professional liability or malpractice insurance to pay for alleged negligent advice or work.
- Don’t EVER “borrow” money set aside for payroll deductions to keep your business afloat. Even if you are a LLC, your company holds those payroll deduction monies in trust, for the benefit of your employees. You, as the owner, are personally liable for turning over payroll deductions to the state and federal government. It’s also a good idea to use a HR consultant and/or Payroll system to keep track of your payroll tax liabilities—I use Gusto, which is straightforward to use.
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