The number one reason why we recommend individuals form businesses instead of operating as a sole proprietor or partner is for liability protection. Generally, a member of an LLC or an owner of a corporation will not be personally responsible for the debts and liabilities of the business. Exceptions: 1) If the member or owner signs a personal guarantee. It is very common for banks and landlords to require new business owners to sign a guarantee which “guarantees” the bank or landlord that if the business is unable to pay back the loan or pay the rent, the member/owner will pay personally. 2) If the member or owner is personally negligent. A member/owner can be held personally liable for his own careless actions if he injures someone while operating the business. Professionals can be held personally liable for their own malpractice. This is why we also recommend getting commercial liability insurance. A member/owner can also be held personally liable for conduct occurring outside the scope of employment. 3) If a court “pierces the corporate veil,” meaning the LLC or corporation was merely a shell for the member/owner to carry out his wrongdoing and served no legitimate business purpose. Three elements must be satisfied before a court will hold the member/owner personally liable:
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In North Carolina, generally, the answer to this question depends on (1) what type of business you own; (2) whether you have bylaws or an operating agreement; (3) whether you have a will; and (4) if you have an insolvent estate.
No matter what type of business, your interest in the business is an asset. Unless there’s a contract stating otherwise, it is an inheritable asset, meaning if you have a will, you can name who the interest passes down to, or if you do not have a will, the interest will pass to your heirs (spouse, children, etc.). If you want to pass your business interest to your son, who will run the family business, instead of it passing naturally to your spouse, you need to have a will drafted. When the individual and the business entity are interwoven, like a sole proprietorship or a partnership, it is important to note that business debts are oftentimes personal and can cause your estate to be insolvent (leaving nothing for your family). This is an important reason to form a business entity separate from the individual. If your business is not healthy, it may cease to operate at your death and wipe out your estate. If you have a contract with other members of the business, you can state what happens to your interest when you pass. This is one of the reasons why we urge people who are going into business with non-relatives to enter into operating agreements – do you really want to be working with your business owner’s spouse after the pass away? More importantly, what happens if the spouse has no interest in running the business? What if she wants to sell or have you buy her out? What if you cannot afford to do so? In addition to recommending our clients enter into operating agreements, we recommend that they incorporate buy/sell language into these agreements. Financial professionals can find inexpensive ways to fund these agreements so that a partner can afford to buy another out. If you own stock in a corporation, that stock will be passed to your beneficiary or heirs just like any other property. While this is not a big deal if you own stock in AT&T, for example, it is a big deal if you own 90% of the shares of a small, family owned business. Again, maybe your business partner does not want to own the corporation with your spouse. If it is your wishes to continue your business when you pass, and your family is onboard, it may be a good idea to put your business interest in the name of a revocable trust. This way, your business interest stays out of your estate when you pass away and the trustee can manage your business interests better than the executor can. Many attorneys will recommend to executors to liquidate business assets because there is too much potential for liability on the executor’s part if he/she attempts to continue to operate the business. We recommend that all individuals get an estate plan in place. However, as you can see, there is more planning to be considered when that individual is a business owner. Feel free to contact Jesson & Rains if you have questions about your business or estate plan. Soon-to-be-business owners often ask us if there is any reason to form their businesses in Delaware instead of North Carolina because they’ve heard or read that corporations frequently form their businesses there. Lately, there’s been a lot of interest in incorporating in Nevada and Wyoming due to aggressive advertising.
For most small business owners, incorporating in a state other than your home state will have very little benefit to you and the business and will likely cost you more money. Not only will you have to file annual forms with both states every year, which costs money, you’ll have to get a Certificate of Authority to do business in North Carolina after your formation paperwork has been approved in the other state, which also costs money. Depending on the state, the formation paperwork could cost considerably more than North Carolina. Some people recommend incorporating in Nevada and Wyoming because those states do not have a corporate tax or a personal income tax. This fact may be insignificant if your business is an LLC, not a corporation, because an LLC oftentimes does not pay corporate taxes. If your business is paying corporate taxes, it may have to pay them anyway because the corporation is based out of and does business in North Carolina. Furthermore, whether you pay personal income tax depends on the state where you live. North Carolina has a personal income tax. Forming in a tax-free state will not save you money on taxes if you live and work in another state. The reason why so many large corporations form or convert their business to a Delaware corporation is because Delaware has a sophisticated corporate law and a Court of Chancery that only hears corporate cases. Based on these thoroughly-developed statutes and judicial opinions, corporate directors and officers are able to better understand their fiduciary duties and shareholders know what to expect. Delaware also has a reputation of being pro-management. Nevada has recently amended its corporation law, which now resembles Delaware’s. However, at one point, Nevada touted that it is even more pro-management, limiting director’s and officer’s liability only to violations involving intentional misconduct or fraud. Shareholders may want to be cautious of Nevada corporations. For most small businesses, these facts are insignificant because they are single member or family-run LLCs. There are no boards of directors or shareholders. However, if a small business expects to grow rapidly and has an eye towards getting venture capitalist funding or an IPO, it may want to consider forming in Delaware. Investors may require that those businesses convert into a Delaware corporation. If it is highly likely that will happen, the business may save some money by forming that way initially. This is a rare case, and converting a business to a Delaware corporation is not very expensive. So in conclusion, like a lot of things we write about, do not always believe what you hear! There are little to no advantages to forming your business in other states, and it is likely that doing so without guidance from an attorney can result in additional costs to you. Please give us a call if you would like more information. Did you know that area community colleges have Small Business Centers that offer FREE classes for community member business owners? The classes offered range from how to get your product on store shelves to bookkeeping and designing websites and doing your taxes.
The colleges offer two-hour classroom seminars, as well as on-demand computer seminars (in case you cannot attend an in-person class). Using the link below, you can search your local community college for in-person classes as well as searching the catalog of on-demand courses from any school that you can watch from the comfort of your own home. Small Business Center Network Charlotte Mecklenburg Library offers classes for adults ranging from learning computer skills (learning to use Excel, for example) to learning how to apply for grants or file business taxes. CMLibrary Schedule Have you heard of SCORE? SCORE stands for “Service Corps of Retired Executives.” SCORE is a nationwide non-profit with thousands of working and retired business professionals who volunteer to support the success of small businesses. SCORE offers free live and on demand webinars for all things business-related: https://charlotte.score.org/content/take-workshop-249 Not only does SCORE offer webinars, but they offer FREE one-on-one mentoring. The Charlotte chapter has over 75 certified mentors that provide one on one mentoring to business owners and entrepreneurs. Sign up for a mentor here: https://charlotte.score.org/content/find-mentor-282 What other legal requirements do you have other than filing the paperwork with the Secretary of State’s office and getting a tax ID number? As we mentioned in a previous article, vendors are going to see in the public records that you’ve started a new business and are going to send you offers in the mail to purchase items like signs that you “legally are required to display or you may be forced to pay federal fines.” As we discussed, this is sometimes not the case.
What about taxes? This is a new business owner’s main concern. First, find a good CPA. They’re the tax experts, not us. If your business consists of selling a service and you have no employees, you likely only have to concern yourself with estimated quarterly income tax. If you’re selling a product, you may have to pay sales tax. If you have at least one employee, you will need to pay FICA Tax (social security and medicare deduction) and submit additional tax paperwork every quarter. You should register your business online with the state at http://www.dornc.com/electronic/registration/index.html. You should also fill out this application because most businesses with one employee have to pay unemployment tax, too. https://des.nc.gov/des. If you have a brick and mortar store, you’ll likely have to pay business property taxes (just personal property tax if it is a leased store). When you hire an employee, we strongly recommend you consult with an attorney or a professional out-sourced human resources company. There are all sorts of rules and regulations and compliance issues when it comes to hiring an employee. You need to know about overtime, meal breaks, minimum wage, etc. Once you get up to three employees, you’ll need to start carrying worker’s compensation insurance. The above information is all general -- depending on the type of business, there may need to be regulatory considerations such as licensing and permitting. For example, we have clients who are professionals who had to get approval for professional licensing boards before opening their business. If you are opening a restaurant that serves alcohol, you have to get your ABC permit. The attorneys at Jesson & Rains can assist you in navigating the business start-up process. As business owners ourselves, we’ve been there! Litigation happens. We believe it’s beneficial to all parties involved to amicably resolve disputes before getting the courts involved; but sometimes that just isn’t possible. Litigation costs can be wildly unpredictable, vary on a case by case basis, and can add up quickly.
Take two similar cases: In “Case 1,” the case moves quickly towards trial but resolves early at mediation. In “Case 2,” the case moves slowly through discovery, with all parties objecting to the other party’s discovery requests; there is a day-long mediation where the case doesn’t settle; there are complicated issues of law to be researched and argued before the Court; and then a costly trial. It is obvious that “Case 2” would cost more money; however, what is not always obvious in the beginning is whether a case is going to follow “Case 1” or “Case 2”’s path. We try our best to estimate costs for our clients and be honest (sometimes brutally) about potential cost, but a lot of the cost depends on your opposing party. For our business clients, and in some limited circumstances, individuals, there may be a cheaper and more predictable way: Alternative Dispute Resolution (“ADR”). ADR has been around for a long time and can be contractually mandated between the parties, usually in the form of mediation and/or arbitration. Mediation is when a neutral third party goes back and forth between the parties in an attempt to negotiate a compromise. Arbitration is a middle ground between mediation and a lawsuit. The parties present their evidence to a neutral third party who will decide the case; however, arbitration is generally far less formal than a lawsuit and costs less time and money because there are no motions filed or discovery exchanged between the parties. There are other advantages to just saving time and money. For example, disputes that a business may not want made public (which would be a matter of public record should litigation ensue) can be resolved in a confidential nature through ADR. Where ADR really shines is in the resolution of complex disputes, like a complex breach of contract dispute or complex construction defect case. Using ADR, the parties can select an expert in the field to act as the arbitrator or mediator, instead of relying on a jury of average people who likely would not have the necessary specialist knowledge to properly decide your case. However, businesses should be careful about blindly throwing in arbitration clauses into their contracts without first consulting an attorney. If the arbitration clause in your contract is not enforceable, then you will end up in litigation anyway. For example, there have been many lawsuits filed recently regarding the Samsung “exploding” phones. People who have been injured when the Samsung phones spontaneously combust are finding that, when they file the lawsuit, Samsung is filing a motion to dismiss the case because there is an arbitration clause contained within the phone’s warranty guide. While the consumer has 30 days to opt out of that provision after buying the phone, the majority of people do not do so because they do not know about it! Further, pursuant to the contract, the proceedings between the consumer and Samsung are secret, Samsung has the right to choose the arbitrator, and, if Samsung wins, the consumer may be required to pay Samsung’s costly legal fees. Seems like a great deal for Samsung, right? However, In January of 2017, a federal appeals court in California ruled that the arbitration clause did not comply with California law and, therefore, the consumers were not bound by the clause. There have been many other cases in recent history where Courts have refused to enforce arbitration clauses against consumers. Frequently, the Court’s reasoning is that the clauses are hidden among other terms (so the consumer is “tricked”), not negotiable, and unfair. The takeaway from all of this should be that, while ADR is a useful tool to move cases towards a quick and often relatively cheap resolution, the arbitration clause needs to be enforceable. Litigating the issue of whether an arbitration clause is enforceable can be extremely costly. Make sure to consult an attorney who can check to ensure that your arbitration clause is enforceable in the states in which you do business. |
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