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The 7 Most Common Legal Mistakes Startups Make

by | May 4, 2016 | STARTING A BUSINESS

In the shuffle of setting up your startup, ensuring all legal requirements are properly handled can seem like just another overwhelming chore, something to figure out later, or – worst of all – something that never gets done and you hope goes unnoticed.

Many new entrepreneurs focus on creating the product, providing services, attracting customers and hiring a good team. That can be a lot to handle by itself. Navigating the legal system is probably not how you’d like to spend a Sunday evening. Most entrepreneurs want their legal needs handled as quickly and efficiently as possible, so they can get back to the business of running the business.

So here’s a quick checklist for the first-time entrepreneur covering the most common legal mistakes you can easily avoid.

1. Waiting Until You’re in Trouble to Set Up Legal Protections

It is no secret that the United States is the most litigious society in the world. While many of these lawsuits are a necessary component of our legal system, a certain portion of these lawsuits are based on nothing more than an attempt by one party to generate a financial windfall from a targeted defendant. To help combat such legally permitted takings was born the concept of asset protection, – the legal techniques of protecting one’s assets from judgment.

Asset protection is based on the principle that since assets held in your name (minus a few exceptions) can be seized by a judgment creditor, assets not held in your name (and subject to charging order protections) are better protected. If you don’t own valuable assets in your name and instead, they belong to a legal entity like a corporation or a limited liability company those assets will not be lost if you loose a lawsuit.

But, if you haven’t set up legal protections before you are sued, it can’t help you once you have been. That’s too late. Preventative care is the only treatment that works in this case. Denial won’t help you, but having a trusted legal advisor to answer questions and help you avoid potential issues can empower you and provide peace of mind. It’s smart to have a professional in your corner to answer legal questions, take many of those to-dos off your list, and ensure the paperwork is set up properly with full legal protection. If you have a business in the United States, Corporate Direct can help and advise you.

2. Not Setting Up a Legal Entity for Your Business or Property

An entity is a separate legal being, such as a corporation, limited liability company (LLC) or limited partnership (LP). All provide much greater asset protection when compared to a sole proprietorship or general partnership. It is the ‘separateness’ of an entity which protects you – the entity’s owner – from unlimited personal liability. Without that separation, if an angry customer sues you, any assets you own such as your house, car or bank account can all be taken should a judgment be found against you. An entity is a business organized according to state law to limit the liability of the owners.

An entity can’t protect you if it is not set up right at the start. Furthermore, it can’t protect you if you don’t properly maintain your entity over the long term.

3. Not Picking the Right Legal Entity

Choosing the correct entity is one of the most important decisions you can make. This one decision will dictate how you prepare your taxes, how you keep your books, how much of your business’s income you keep and how much you don’t. It will dictate your profits and losses, the financial security (and safety) of your family, maybe even your health and happiness.

Do not take the decision of which corporate entity you choose lightly. There is no part of your business that will not be affected by it.

Here are a few rules of thumb:

  • Don’t operate as Sole Proprietor: This leaves you vulnerable to unlimited personal liability. You’re also more likely to audited by the IRS.
  • Don’t Operate as a General Partnership: a general partnership is double the liabliabity risk without any reward.
  • Don’t use a C Corporation for Real Estate Investing: You’ll end up paying double the taxes. It simply doesn’t make sense.
  • Don’t Try to Save Money with a Series LLC: This newer and untested entity type isn’t available in all states and case law isn’t well established in the courts. This means the legal protections are not as established as other entity types.
  • Setting up a Single Member LLC is Risky: Courts are starting to deny sole owner LLCs the same protection as multiple member LLCs. The reason has to do with the charging order.

For more information please see my book Run Your Own Corporation. If you’re looking to form an entity and unsure of what the best choice is for your situation, our incorporating specialists are here to help. For more information or assistance please call 1-800-600-1760.

4. Not Having a Registered Agent

Every corporation, LLC, or Limited Partnership must have a registered agent (also known as a “resident agent,” “statutory agent” or “agent of process”) in their state of formation and in any state the company qualifies to do business in. The registered agent ensures you receive all important legal documents such as service of process (meaning a notice of a lawsuit) and official governmental notices. You can be your own registered agent in some states, but some also require that you be open from 8 a.m. to 5 p.m. If you listed your house as the registered agent location, you might not always be home and that could be a violation.

In the case of a lawsuit, it is important to be notified as soon as possible since most states only allow you 30 days to answer the complaint. Without an answer, you will typically lose the case. It is important to deal with a professional, established company who will get notices to you promptly. We have been providing this critical service service for over 30 years and currently help more than 13,000 clients.

5. Forgetting about Trademark, Copyright or Patent Protection

Registering a trademark is an important step in any business venture – one that should not be overlooked. By protecting the name of your business, products or services, you ensure that others cannot use the trademarked words or designs.

If you fail to secure such protection, anyone can start using your ideas, and in some cases they may demand that you stop using what they now claim is their trademark.

When you have secured the rights to your trademark, it is an asset that increases in value and can be sold or licensed to others. Therefore, registering a federal trademark is an essential component to any business and wealth building strategist. Copyright and patent protection may also be relevant to you depending on your business and product.

Copyright grants the creator of an original work exclusive rights for its use and distribution and tends to be for expressive works like books, screen plays, advertisements and similar works.

A patent is a grant of protection for an invention. The owner of a patent has the right to stop someone else from making, using or selling the invention without their permission. However, certain things like recipes are considered trade secrets and are not available for such legal protections.

6. Failing to Meet Legal Requirements Resulting in Lost Legal Protections

This is a surprisingly common mistake. In fact, 50% of sued businesses and real estate ventures are not protected against the common legal attack of piercing the veil court cases — meaning the owners can lose their possessions. Learn the three steps to take to protect your business, your real estate & yourself.

The first, we’ve already mentioned, which is having a professional registered agent.

The second issue is caused by having incomplete paperwork for your entity. You will see the offers for a $99 (or less) corporation. This entails filing the Articles of Incorporation (for a corporation) or Articles of Organization (for an LLC) with the state. That’s all that is done in most cases.

Perhaps you are not told that you need bylaws/operating agreement, a registered agent, minutes of the organizational meeting or the issuance of ownership certificates, among other requirements called corporate formalities.

And you think you are fine.

The problem is that by not following the corporate formalities you open yourself up to unlimited personal liability if your corporation or LLC gets sued. If you haven’t met all the corporate formalities, you can be held personally responsible for the corporation’s claim. That defeats the whole purpose of setting up your entity!

You need someone to make sure your business is following the law and that you’re filing the required paperwork every year. This is not intuitive to people who have not spent years in law school.

7. Having Poorly Drafted Operating Agreements

The LLC is now the most popular entity to use. The reasons are many. You can choose your taxation, so that you can be taxed as a partnership, S Corporation, C Corporation or disregarded entity. No other entity offers such flexibility.

You have excellent asset protection via the charging order, especially in the states of Wyoming and Nevada. The LLC also allows for maximum flexibility in drafting the operating agreement (known as the Company Agreement in Texas), which is the entity’s roadmap for operations.

The problem is that many discount promoters ignore the importance and potential of the Operating Agreement (“OA”). As discussed in the section on Incomplete Paperwork, many of them don’t even provide this important document. Those that do offer only a skeleton version that will not completely protect you.

For example, some of the internet’s largest formation firms offer an OA that is extremely incomplete – just four to six pages long in some cases. (Ours is 35+ pages.) A key failing of their very short OA is they allow for the free transfer ability of membership (ownership) interests within the LLC. This is contrary to one of the most important features of the LLC – the ability to keep unwanted potential owners out.

Here’s what all that might mean to you… Suppose you have an LLC with another friend and you are 50/50 members (owners). If your friend gets sued, you obviously want to keep the attacker out of your LLC. If the attacker wins a lawsuit and gains control of those shares, there will be all sorts of havoc wrought.

As a new 50% owner he can block any of your moves. He can try and force a sale of the company to get paid the money your friend owes him. Your LLC becomes a nightmare.

Don’t let any of these issues threaten to destroy your business or impoverish you. Take action to protect your startup.

Protect Yourself & Your Business

We have been creating and maintaining entities for our clients for over 30 years. We have clients ranging from everyday people…to people worth hundreds of millions of dollars… to celebrities you would recognize.

One of those is Robert Kiyosaki, best-selling author of Rich Dad, Poor Dad. I am one of Robert’s Rich Dad Advisors and I have been helping protect his many corporations and LLCs for over 15 years.

The fact is, we’re an honest and trustworthy company that can help you decide what is best for you. All it takes is a simple email or call. Get in touch and see how we can help you.

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The Top 12 LLC Advantages and Disadvantages

by | Jul 1, 2015 | BLOG, C CORPS S CORPS, Corporate Direct, entity types, Start a Business, STARTING A BUSINESS

When looking to start a business or protect investments you have several options in the type of entity you can form. As with anything, there are advantages and disadvantages to limited liability companies.

Advantages

  • It limits liability for managers and members.
  • Superior protection via the charging order.
  • Flexible management.
  • Flow-through taxation: profits are distributed to the members, who are taxed on profits at their personal tax level. This avoids double taxation.
  • Good privacy protection, especially in Wyoming.
  • This is a premier vehicle for holding appreciating assets, such as real estate, stock portfolios, and intellectual property.
  • Extraordinary flexibility in the ability to allocate profits and losses to members in varying amounts.

Disadvantages

LLCs and the Charging Order

One of the great asset protection advantages of the LLC is the charging order.

Charging order protection arises from each state’s law and is a key strategy for shielding your assets from attack. As with anything in the law, the charging order is subject to change and interpretation by the courts. Some states view the statute differently than others, which is why it is important to choose the right state when forming a limited partnership (LP) or limited liability company (LLC). It is also important to keep up on the new court cases and trends in this area to keep yourself better protected. Remember, the LLC has only been widely used in the USA in the last 25 years or so. We are just now starting to see court cases defining their scope and use.

Going back to the original statute (the rule passed by each state’s legislature) we consider section 703 of the Uniform Limited Partnership Act. It states that if a partner of an LP owes money to a judgement creditor (one who has gone to court and prevailed) the court may order a ‘charge’ against the partner’s interest to pay the judgement creditor. Thus the term ‘charging order’. This rule also applies to LLCs.

For example, if John owns a 50% membership interest in XYZ, LLC and John owes money to Mary after losing to her in court, Mary can seek a charging order to receive John’s 50% share in the distributions from XYZ, LLC. Of course, John’s other partner Carlos is not as keen to this, but any disruption is minimized with the charging order. Mary does not step into John’s shoes as a substituted partner. She can’t vote and tell Carlos how to run the business. Instead, she is only assigned the distributions that would have been made to John.

Again, the charging order is a court order providing a judgement creditor (someone who has already won in court and is now trying to collect) a lien on distributions. A chart helps to illustrate our example:

illustration of charging order

In our example, John was in a car wreck which injured Mary, the other driver. Mary does not have a claim against XYZ, LLC itself. The wreck had nothing to do with the duplex. Instead, Mary wants to collect against John’s main asset, which is a 50% interest in XYZ, LLC. Courts have said it is not fair to Carlos, the other 50% owner of XYZ, to let Mary come crashing into the LLC as a new partner. Instead, the courts give Mary a charging order, meaning if any distributions (think profits) flow from XYZ, LLC to John then Mary is charged with receiving them.

Mary is not a partner, can’t make decisions or demands and has to wait until John gets paid. If John never gets paid, neither does Mary. The charging order not only protects Mary, but it is a useful deterrent to frivolous litigation brought against John. Attorneys don’t like to wait around to get paid.

This short video also explains the charging order:

But what if there is only a single owner?

The Difficulties of Single Member LLCs

In a Single Member LLC, there is no Carlos to protect. It’s just John. Is it fair to Mary to only offer the charging order remedy? Or should other remedies be allowed?

llc advantages and disadvantages charging order single member llc

A key issue is whether the charging order applies to a single member (one owner) LLCs. There is a nationwide trend against protecting single member LLCs with the charging order. Courts are starting to deny single owner LLCs the same protection as multiple member LLCs. The reason has to do with the unique nature of the charging order.

In June of 2010, the Florida Supreme Court decided the Olmstead vs. FTC on these grounds. In a single owner LLC there are no other members to protect. The court allowed the FTC to seize Mr. Olmstead’s membership interests in order to collect. Other states have followed the trend.

How Corporate Structure Can Increase Protection

Say you have a property in Oregon. That property is entitled to an Oregon LLC, which is owned by a Wyoming LLC. You then invest in a property in North Carolina, so you set up a North Carolina LLC owned by the Wyoming LLC.

If a tenant of your Oregon property sues over something that happened on the property, they have a claim against the Oregon LLC, not against you personally. They can’t get at your North Carolina LLC, and they can’t get at equity held on your personal property.

As you can see it’s beneficial to spread your properties across multiple LLCs. If you have 10 properties all in one LLC, it becomes a target-rich LLC. Often, we recommend only having one property per LLC. You may wish to have two or three properties in an LLC, but it really depends on how much equity you have in each property. The structure of your business really comes in to play during an inside attack, which is where the lawsuit is against an LLC, not the owner.

In the case of an outside attack, where the owner of the LLC is the target of a lawsuit, the charging order comes into play. In our example above where Mary is trying to get at John’s property, let’s assume John is the owner of a Wyoming LLC, and he has LLCs in North Carolina and Oregon. The car wreck has nothing to do with John’s Wyoming LLC, the holding in Oregon or the holding in North Carolina, so Mary can only go after John. And since John has a Wyoming LLC, even if he is the sole owner of the Wyoming LLC, Mary’s only option is the charging order. If the Wyoming LLC makes no distributions, Mary gets nothing. If the Oregon LLC and the North Carolina LLC make no distributions to Wyoming, Mary gets nothing.

This is not a great situation for attorneys who are on a contingency fee. They get a percentage of what is collected and it’s not a really good way to operate if they have to sit around get a charging order against the Wyoming LLC and then sit around and wait to get paid. Attorneys, being rational, economic animals are going to take the next case that has insurance instead of waiting for John to pay Mary.

You want to use the strategic positioning of the Wyoming LLC, which will own all your other out-of-state LLCs. States like Oregon and North Carolina may not protect the single member LLC, so you really need a Wyoming entity for protection in a case like the car wreck example. The Wyoming LLC creates a firewall against attorneys and frivolous lawsuits.

Entity Structuring is Our Specialty!

 

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A General Partnership is an Ugly Entity

by | Jan 8, 2015 | BLOG, Corporate Direct, STARTING A BUSINESS

If you thought Sole Proprietorships were bad, just wait. The General Partnership really is the ugliest entity.

A General Partnership offers no asset protection and doubles the liability because you are also responsible for your partner’s mistakes.

Unlike a Sole Proprietorship, a General Partnership requires two owners or partners. Unfortunately, like a Sole Proprietorship, a General Partnership, offers no asset protection. Again, there is no charter from the state, no legal separateness and, accordingly, no protection.

A partnership can be formed with a simple handshake between two or more people who agree to work together. You don’t need a partnership agreement or any sort of written document. Such a loose agreement also leaves no paper trail for the partners to go back to when things go south. When partners become adversaries and there’s no written partnership agreement in place, the laws of the state in which the partnership was formed take precedence, and the partners are left without any choice in the matter. Similarly, if one partner leaves, dies or goes bankrupt, the partnership is terminated and the partners are liable for the company’s debts and obligations.

I will not set up a General Partnership, ever. Not only is there too much liability but it requires a great deal of document drafting. A general partnership agreement includes, at minimum:

    • Type of business
    • Finance requirements (the amount each partner is expected to contribute to financing the company up front)
    • Rights and duties (what is expected of each partner)
    • Dispute resolution procedures
    • Compensation (the method of sharing profits and losses)
    • System authorizing cash withdrawals and salaries
    • Termination procedures (how the partnership will be dissolved if it becomes necessary)

For all the time and energy it takes to set up an ugly entity, you might as well set up a good one.

The above is an excerpt from my book Run Your Own Corporation. Click here to purchase the full book.

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It Takes Two….to Buy a Business

by | Aug 8, 2014 | BLOG, Corporate Direct, STARTING A BUSINESS

It Takes two to buy a business

By Garrett Sutton, Esq.

Just as with so many other things in life, it takes two to buy a business. A buyer and a seller are the key ingredients. Brokers, accountants, lawyers and other experts make sure everything is in the right measure and you don’t get burned. But without a willing buyer and a motivated seller there is no deal. And they may have more in common than they think.

  • Both the buyer and the seller want the company sold.
  • Both want as painless a process as possible.
  • Both want it over quickly.
  • Neither wants to get very far into the deal and have it fall apart.
  • Neither wants the word to get out that the deal is in process.
  • And neither wants the business to fail.

With so much in common, how could anything go wrong? Simple, buyers and sellers speak different languages. Each is reading for different clues, deciphering vastly different nuances, viewing the whole process through a different set of lenses. And this is exactly as it should be. Friendly skepticism is the ideal in all adversarial transactions.

Former American President, Ronald Reagan, used to chide the then-Soviet Premier, Mikhail Gorbachev, with the phrase “Trust, but Verify.”  The United States was willing to accept what the Russians said was true only after the United States had verified it to be true.  As with nuclear warheads, the same is true for deal points. While negotiations may be pleasant exchanges and the buyer and seller may become best buddies after all is said and done, neither should lose that sense of skepticism and the need to verify key points.

Former American President, Ronald Reagan, used to chide the then-Soviet Premier, Mikhail Gorbachev, with the phrase “Trust, but Verify.”

It goes without saying that the wants and needs of buyers and sellers are often at odds with one another. Knowing these wants and needs, being able to put yourself in the other party’s shoes, will help in reaching a deal that is acceptable to both sides. Or it may just as easily assist in a deal not coming together.  It should be noted that not every deal is finalized, nor should they be concluded.

Buying and Selling a Business

Some deals you will walk away from, a few you will run from.  By following the key elements I outline in my book, Buying & Selling a Business, and by using your intuition and judgment, you will know which deals to complete and which to discard as unrealistic, overpriced or downright scary.