Personal Liability Protection
Now that we’ve gone through some of the primary considerations you’ll need to keep in mind when determining a suitable business entity in Texas (or anywhere in the country, for that matter), let’s dive a little deeper. Establishing and maintaining the framework that aligns with your business goals is really important, so continuing to explore this topic in greater detail is completely worth it, trust me.
Most business filings will shield your personal finances from anything that happens within the life of your business. This comes with a caveat, though: You have to make sure you and the entity are truly separate. This means you have to separate your expenses; you can’t use company funds for personal use. If you do, you risk opening yourself up to personal liability — piercing the corporate veil.
It’s not entirely common, but you can lose your personal liability protection if, for example, an executive from your company uses funds for private use, not business expenses. It isn’t limited to that, though. You can also suffer this exposure if an executive from your company is found to have been making decisions that enrich themselves and cut against their fiduciary responsibilities to shareholders.
Investors or shareholders can argue the executive is, in essence, using the corporate umbrella as a shell and, thus, should not be afforded the benefit of personal liability. This creates a situation where the executive can be accused of piercing the corporate veil. If this argument is made successfully, the party that wins the case will be entitled to receive financial compensation from the executive’s personal assets – even going as far as to draw from their personal bank account in some instances.
Avoiding this is simple, although it may take some work — just make sure your bookkeeping is accurate, and your expenses are separate and valid. Many people fall into the trap of thinking that they can basically write anything they want off as a business expense. What makes this challenging is that it’s based on a partial truth, and the restrictions in place vary by state.
Even if you’re working from a home office, certain regulations apply when prorating home office expenses. The key here is having an accountant and CPA you know well and trust who will advise you on what a valid business expense is and the relevant thresholds you have to abide by.
Litigation And Contracts
After you’ve got your idea and decided on a structure for your business, don’t just put on the blinders and start hustling your way to riches. Now the fun really starts – it’s time to ensure that you have all the necessary protective measures in place as far as your personal liability is concerned. This will look like different things for different people, so it’s extremely helpful to sit down with an attorney who can help you determine which steps will position you in the best possible scenario.
I understand that this isn’t what most business owners and entrepreneurs prefer to focus on, but litigation is a very real risk that can spell the end of your business in worst-case scenarios. Fortunately, taking just a few simple steps can pay massive dividends in this department later on.
One of the most important things you can do in this regard is to draft strong contracts. Unfortunately, this is where many people make what is probably their biggest mistake. So often, I have clients who have been doing well in business and are making good money, but come to me with no solid contracts in place. At worst, there’s no contract at all, at best, they only used a free template they found online.
I don’t say this just because I spend countless hours cleaning up poorly drafted contracts. (Though, as you can imagine, this isn’t the most satisfying part of my job by any stretch.) I say this because contracts are genuinely important, and for some reason, they are nowhere to be seen on most people’s radars.
The reality is, I see the vast majority of my clients for the first time because they’re facing a situation where another party is attempting to get out of their contract. So often, though, when I go back to look at the language in the contract, it’s unclear at best – and having your contract open to a number of possible interpretations is not a position you want to be in.
So, how do you create a strong contact? To start, it’s important to do what you can to manage any and all of the issues you can foresee before they ever arise. For most people, these issues are going to stem from situations having to do with payment or termination. Sure, there’s a chance you’ll face a situation of non-solicitation where an independent contractor stole your clients, but this problem is nowhere near as constant as those related to payments and terminations.
Next, you have to make sure that clauses in your contracts are locked down and every party involved has an absolutely crystal clear understanding of their responsibilities. This doesn’t necessarily have to express itself as a zero-sum game where one party benefits at the expense of the other.
As such, I tend to adopt a “Let’s not make this unconscionable for both sides; let’s make it fair” type of approach – and I advise my clients in a way that aligns with this. This isn’t just the decent thing to do; it’s the most effective thing you can do. The more fair a contract is, the more likely it’s going to be enforceable, which is exactly what you want if things ever escalate!
A good contract is something for you to fall back on that is abundantly clear and that makes sense for both sides. It will plainly describe your and the other party’s responsibilities: I performed X, Y, and Z services. Therefore, you have to pay X, Y, and Z. A weak contract does not consider both parties’ interests – you can’t say: Even if I do nothing, you have to pay $5,000 upfront, and this will be completely non-refundable. Not only is that second position hard to enforce, but it’s not even fair, to begin with.
With that said, there are important nuances to consider in each industry. For example, one of my clients in the event planning space comes to mind. If they lose a wedding planning job, that’s a massive loss of revenue, so contracts that include non-refundable deposits become a key concern. In cases like this, being able to enforce the terms of a contract or otherwise exercise recourse will depend on your ability to showcase the tangible impact on business operations.
If an event is canceled, that wedding planner not only loses the income they would have had from the job had their client not canceled but they are left in a position where they cannot secure other work on the same day, given the nature of the termination of the agreement. These are easily 5-figure opportunity costs they incur as a result. This clearly highlights the rationale behind non-refundable terms and why it is important to be well-versed on this front, particularly as it pertains to your specific industry.
When You Have Partners
Ensuring smooth operations and taking proactive steps to avoid future conflicts within your business starts with comprehensive entity formation and having robust documentation in place, especially if you have partners. For LLCs, a solid operating agreement among managing members is absolutely key. For corporations, you’ll need detailed articles of incorporation and formation documents that outline the roles, duties, and responsibilities of shareholders, executives, and board members.
These documents serve as more than just administrative legalese; they lay the groundwork for resolving disputes and navigating challenges you may face down the road. In my opinion, what happens more often than not is that people are so gung-ho about starting their business that they treat these formation documents as though they’re just items off a checklist. They fail to recognize them as something more — like a preventative antidote to the disease of a dispute or a framework for an amicable dissolution.
In fact, this is a key point: I tell all of my clients with partners or managing members that it’s crucial to discuss what might happen in the case of dissolution. No one wants to have this conversation – and I understand why – but it’s a conversation that must be had, and there’s no way around it.
The reality is, the reason for dissolution isn’t always born out of animosity or conflict, despite that being the natural default people assume when they think about the topic. For example, what happens if your partner unexpectedly suffers a debilitating health issue and they can no longer handle their responsibilities? By discussing dissolution up front, you protect yourself in the event that anyone needs to get out of the business, ultimately protecting your long-term best interests…
These situations occur more often than you might suspect. If your contract doesn’t allow for an amicable resolution, how do you come up with a fair solution? How do you determine what they get back? Do they get their original capital? Do they get a prorated amount or the value of the company at the time? You see how quickly this can become intensely complicated, and figuring it out on the fly will only add significant amounts of stress to you and your team.
For more information on Determining A Suitable Business Entity In Texas, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (214) 307 9868 today.
