In my first business-themed blog posting (“10 Things Entrepreneurs Should Deal With Before Start-Up”), I asserted that it is necessary to deal with business formation from the beginning. In this blog, I will explain what I mean by “business formation” and why it is important to go through this process.
Business formation is the act of formally creating a new legal entity for your business activities. In most cases, the legal entity will be a limited liability company (LLC); other times, will be a corporation. Such an entity can be formed by having a lawyer: (i) file certain documents with the state and (ii) draft other documents to set out how the business will be operated. More specifically, these documents should also set forth the rights and obligations of the business owners to each other and the business (aka, the enterprise). They will specify how the profits and losses of the business will be allocated among the owners, and how the business will be taxed. Most importantly, this is done to shield the personal assets of the business owners from liability for damage done to others (by the owners, their employees, or other agents) in the ordinary course and scope of business.
Protection from personal liability is the most critical reason to go through the process of formal business formation. In fact, it is crucial regardless of whether you are a sole entrepreneur or if there will be multiple co-owners (aka, equity owners) of the business. Consider, in everyday life we are all subject to liability when our actions cause damages to other people. For example, if you cause a car accident and a judgment is entered against you, then you will have to compensate the other parties in the accident for their hospital bills, pain and suffering, and property damage. If you do not pay the judgment, then the creditor can place a lien on your house (hypothetically, they can even foreclose on it), garnish your wages and bank account, even seize your personal property (your car, valuables, etc.).
Few of us worry about this because there is little risk that we will have these troubles in our personal lives. After all, we mitigate the consequences of liability for accidents by purchasing insurance so that we can pay judgments or settlements that arise from freak events like car accidents. In most instances, we will have purchased enough insurance to pay a judgment for a routine car accident. If we have not done that, we run the risk of paying the excess out of our pockets.
When we start doing business, we take on much greater risk. For example, if Dave starts a sub shop and hires Ron to work for him without creating a new legal entity for the business and Ron commits a tort (accident or other misconduct) against Dave by serving an uncooked burger that kills Cathy Customer, then Dave and Ron will both be sued by Frank, the fiduciary of Cathy’s estate for a tremendous amount of money. Under the law, Dave will likely be held liable for employee Ron’s negligence. After Frank takes a judgment for the estate, he can seek to collect on the judgment by attaching Dave’s personal bank account, house, and cars in addition to, say, his business equipment such as the deli slicer and burger grill.
You see, without creating a business entity such as a corporation or LLC to shield his personal assets from liability for damage caused by his sandwich business, Dave remained responsible not only for his own misconduct, but also for the torts of Ron. He would also be responsible for the misconduct of any partners if he had any.
By contrast, if Dave had incorporated or even formed an LLC, Frank would be unable to successfully sue Dave and move to collect against Dave’s personal bank account, house, car or other personal assets. Rather, Frank would be left to sue and collect against the business. He would probably be able to prevail in a claim against Ron, but that is beside the point; focus on Dave. By skipping business formation, Dave failed to put a “forcefield” around his house by creating a separate legal entity to shield him from the risks associated with the business activities.
Business formation allows you to create a new legal entity distinct from your personal identity. You can then separate your business property (i.e., the deli slicer and burger grill) into the business entity. This separation of business property from personal property — and the practice of maintaining certain other company or corporate (as the case may be) formalities — will allow you to better protect your personal assets from the reach of a business creditor like Frank. Of course, there is more to this, but you get the point.
In Ohio, you can obtain protection for your personal assets by forming a limited liability company or a corporation. If you are merely concerned about protection from the misdeeds of your business partners, you can create a limited liability partnership. There are many considerations to take into account when deciding which entity to form. This blog will discuss other considerations in future postings.
The Ondrejech Law Firm, LLC offers business formation services at flat fee rates. Billing arrangements for multi-owner business formation services are determined on a case by case basis. Call 330-441-2027 or email firstname.lastname@example.org. If you’ve got legal issues, I’ll find solutions. Let’s get to work.
 It is possible to do some or all of this yourself, but I provide this service for a flat fee.
 Of course, you would have a right to a trial under those circumstances, but move past that and assume you lose for purposes of this post.
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