Costly Mistakes Made With Your Business Entity

Investing in a powerful tool and not using the tool properly does not make a lot of sense. I know when it comes to running a business it requires multiple hats to wear and very often you are off and running on 10 different projects, calls, appointments, presentations… and perhaps the very foundation of your business may be in jeopardy. Here are the top costly mistakes I have seen made over the past 15 years:

Not completing the transition from a sole proprietorship to a separate legal entity. If you started a business in your own name for a few months before you formed an entity odds are part of what you did you completed as an individual and you need to connect the dots to the new entity. If you filed a DBA (doing business as) with yourself as the applicant that needs to be cancelled and re-linked to the entity. That means your entity needs to be the applicant, not you! If you don’t do this you still are exposed to unlimited liability and filing a schedule C with a higher audit potential. Next, point is to open a bank account in the name of the business, not just keep the account in your personal name. Use a business credit card in the name of the entity, not just your personal credit card and keep track of expenses. You will want to minimize the amount of debt that shows up in your personal name. Update all affiliate programs, vendors with your new entity information so any income is going to your business entity, not to your name personally. Update your websites, business cards, letterhead with the new name of your business. Another important tip make sure your website is in compliance, most are not.

Funding concerns. 95% of businesses fail within 5 years and undercapitalization is the #1 reason. The pattern I have seen is that small business owners are mostly hoping for revenue to come in as the primary source of money to grow their business. What happens if your revenues are off or don’t come in at all? You may be working on that great new product and all your emails go out and no one converts. That is a real problem. The key is to model success. Almost all successful companies do not use only their own money to grow. I know you know the concept, “OPM”, other people’s money, yet are you doing that? Are you only self funding your business on your own personal credit? Did you know that once the entity was filed the business credit bureaus will start creating a file. They scan the Secretary of State’s records to create a file with any new filings. They look for the name of the business, the start date, and name of the officers/managers the address… If you are not paying attention on how you fill out forms with the business address, business license, state forms you can create disconnects in the database. In one business credit bureau, NCP is spelled four different ways. The NCP part is the same, but one way has “Inc.”, one has “,Inc.” other has “, Inc” and the last one is “Inc”. Did you notice the differences with the comma and period? That created four different files! Don’t make that same mistake. Unlike the personal credit bureaus, the business credit bureaus are very difficult to fix any mistakes. They have their own set of rules and are not set up for changes after mistakes happen. This creates a problem when it comes to developing credit for your entity because you basically have one shot at the apple to get it right the first time. Banks and vendors are very interested in your financial strength of your company. Now joint venture partners can check you out for free to determine who stable is your operation. You may be losing business and not knowing it. It is really a must to be financially solid in your business and your developing business credit is a must for your long term success.

Safe and risk asset. Mixing asset classes is a major risk to your wealth that is unnecessary. A risk asset is any asset that would cause liability to your entity. That may be a business, real estate, equipment, again, anything that may cause liability to an entity. A safe asset is one that does not cause liability to an entity, like cash, ownership of another company, investments… If your business falters and you need to reply upon your safe assets to recover short term, why unnecessarily put your safe assets at risk? It happens all the time. There are two reasons this may be happening to you, first, you have thought that your amount of safe assets are not large enough to protect. Imagine having $25K in a brokerage account in your name and losing all of that because of a personal lawsuit. Wouldn’t you wish that you took the time and invested a small amount to protect that amount? Most clients will tell us they will get to it later but never do. Don’t make that mistake. Set in place a safe asset LLC in your home state and transfer your safe assets into it immediately. This LLC does not have to be based in Nevada, because the protection of the entity veil is not important in this situation because as a safe asset entity there should be no one to sue the operating entity because there are no public clients! This is why your home state is fine for a safe asset LLC.

Now clear on who does what? A partner can help you grow a business quickly and destroy it even faster if you are not on the same page. Very similar to being married. I have been married for 16 years with three girls and it is a lot of work and requires meetings, discussions to do the best to be on the same page. Business like marriage can be very exciting at first and you really need to be able to communicate well as to what you are looking to accomplish. The fun part of business is discussing how you will bring in revenue and all the possibilities that can happen with profits. The part that is not a lot of fun is the expense side of the ledger. First, you must agree upon what is actually considered an expense, does that include things like cell phones, travel, meals… ? You may assume this is obvious but typically that is not the case. What happens if revenues are way off and there is not enough money to pay each partner and you need more capital from each partner to keep it going? This can be a very uncomfortable problem. It is best to presuppose the challenges ahead of time and see if you can calmly discuss through them and come up with solutions that make sense. If you can’t get to first base on the uncomfortable parts even before you get started that is a bad sign and perhaps you should NOT be a partner. If fact, odds are the business is doomed to fail if you can’t get through some of these basics uncomfortable discussions from the start. Now, that does not mean your partner is telling their spouse the same story. That can and often does create more issues. Having as much in writing from the start and a business plan in place makes the most sense. Almost ALL, not all, but close, partnerships that refuse to take the time to put things in writing fail. It is like clockwork. If anyone wants to start a business with you and they refuse to put things in writing, run! Most of the time the only one that makes money in that situation is the attorney’s after the partners sue each other! Take the time to be clear and put it in writing!

That is your top 4 of the most costly mistakes that can be made with your business entity. There are more, but these are the biggest. The key is to take a few minutes and determine if any areas you are making mistakes and if so set an appointment on your calendar now to solve them!

Choose the Right State For Your Business Entity

I have helped thousands of people set up Limited Liability Companies (LLCs) and Corporations in Montana and a few other states. Being a Montana attorney, the majority of the LLCs and Corporations I have helped form have been in Montana. For certain reasons, I have advised clients to form their business entity in another state, sometimes sending business away because it was in the best interest of the client.

Of the LLCs I’ve helped form, many have been for non-Montana residents to use as holding companies for vehicles. This strategy is useful for certain people to minimize tax and registration fees depending on the use of said vehicle. Other LLCs I have helped form have been for various profit enterprises or holding companies for real property, both rentals and private property. The LLC is an extremely versatile business entity and a preferred entity for many uses. However, because I have helped so many people with LLCs, I also get a flood of calls regarding LLCs and their use that is not in the best interest of the person calling. Therefore, I do spend a fair amount of time educating people on the benefits of LLCs, and most important, where to organize the entity related to their goals.

The organization of a Montana LLC is great for the tax and registration savings on a vehicle as long as the person operating the vehicle complies with the State laws of the operator’s State of residence and the use of the vehicle. The organization of a Montana LLC is great for a Montana based for profit business. It is also a great entity to own real property located in the State of Montana.

The problems arise when people from different states want to use a Montana LLC to own real property in different states, or to do business in different states. Yes, the LLC is a great business entity to use for asset protection, tax, and liability purposes, however, it must be organized in the right state to provide the most benefits.

My home state of Montana is a great state for vehicles because of the sales tax laws. Nevada is promoted all the time as the State to form business entities for income tax and asset protection reasons. And there are tons of promoters and services that will help you form these entities without providing you any guidance of the law. Sure they are experts at forming business entities. That means they can file the proper forms for you. But have they advised you on the law? I strongly suggest you speak with an attorney rather than some of these other promoters. Recommending everyone set up a Nevada entity, or a Montana entity, is poor advice at the least, and it may cost you much more in the end than paying an attorney up front.

This is why it is poor advice and may cost you. You might not have any liability protection at all! Yes, that’s right, the entity you set of for liability protection might not provide an ounce of that protection. Each State’s laws are different, so you really need to talk to an attorney in the state you reside in or are doing business in. However, in general you need to know that the asset protection and liability protection provided by a business entity is only provided by the State that the entity is formed in or registered as a foreign entity where the entity is doing business.

This means that if you are operating a for profit business with a Nevada or Montana business entity in a state other than Nevada or Montana and you have not qualified the business entity to do business as a foreign entity with that state’s Secretary of State or governing body, there is most likely no protection. If a business entity is doing business in a state where it was not created and was not qualified as a foreign entity, the owner or owners of the business may be held personally liable for any debt or obligation incurred by the entity.

Therefore, I usually recommend to people that they form business entities in the state where they will do business, and form business entities for owning real property in the state where the real property is located. If you are going to use a business entity formed in a different state, you need to qualify it in the state where you will do business or own real property. (This means paying the correct fees and filing the required documents to both states)

For certain situations, there are advantages to forming business entities in Montana, Nevada, Delaware, etc. However, it really depends on what the goals and objectives for having a business entity are, and where you will be doing business or purchasing assets. If you don’t do things right, you may not have the protection you believe you have. Do yourself a favor and seek out qualified advice before forming your entity, and remember that there is no single solution, single business entity, or single state that is best for everything or everyone. Do a little homework, ask qualified people, and you will be able to maximize the use of your business entity to satisfy your needs and goals.