Business Entities – Avoid These Pitfalls

In our modern society, you can get sued for just about anything. All it costs is a couple hundred dollars to file a lawsuit. If you are starting a business, you need to protect yourself.

Given the number of lawyers [including me] and lawsuits in the country, most business owners know it is wise to open a business entity to protect their personal assets from lawsuits. By definition, businesses offer something to the public be it services or goods. Inevitably, a problem arises. The problem can turn into a full blown dispute and then lawsuits are filed. If your business is not protected by a business entity, this can result in a judgment that can be collected both from business assets and your personal assets. In short, a disaster. Forming a business entity creates a shield that protects your personal assets from such judgments so long as you stay away from general partnerships.

While you probably already know you need a business entity, you probably do not know there are pitfalls to avoid when forming them. Knowledge is the key and knowledge I will give you. Here we go…

1. Equal Equity – In many situations, a business is owned by two people. When they go to form an entity, they often each take a 50 percent share. This is a mistake. Why? If a dispute arises, how are you going to solve it? Each party has 50 percent of the voting shares, to wit, a decision cannot be made. In a worse case scenario, a judge may resolve such a dispute by dissolving the business and distributing half of the assets to each. So much for your future business plans. If nothing else, you are looking at total deadlock in the business.

2. How Many Businesses? – Another major problem I see with businesses is they often come up with multiple ideas that work, but put them all at risk by using the same business entity. If you have multiple business lines, form a distinct business entity for each one. If one gets sued, the others will not be impacted or face the risk of a judgment.

3. Equity is Gold – The equity in a business entity, such as shares in a corporation, should be treated as gold coins. Would you haphazardly give out gold coins? Of course, not. Yet many businesses will trade large amounts of ownership equity for relatively small sums. This often occurs at the outset of the business when money can be tight. If the business takes off, keep in mind it will grow in value. As it grows, you will really regret giving away 10 percent of the ownership for $20,000 to loan shark Lou. If you need cash, try to get loans from people secured by stock in the business.

Once you make the decision to form a business entity, you need to take the time to think through what you are doing. How will problems be resolved? How will ownership be handled? How much money will you need and where will it come from? All of these questions must be addressed or you could really regret the decisions you made down the line.

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