I have noticed a common misconception among many Pittsburgh small business owners with regard to the legal protection that they receive by incorporating. These business owners, many of whom are the sole-shareholders in their corporation, mistakenly believe that the simple act of incorporating and filing the necessary documents with the state will offer them complete protection from liability for the acts of the corporate entity. This is a false sense of security based on a common misconception about Pennsylvania corporate law that I address in this post.
It is true that perhaps the most fundamental advantage in creating a corporation for your small business (as opposed to forming a partnership which is often better for tax purposes) is the protection from personal liability that the corporate identity provides to shareholders. The state allows the corporation to be its own legal entity with its own legal liabilities, thus protecting those persons who own the corporation from personal liability. But Pennsylvania, like many other jurisdictions, allows plaintiffs suing a corporation the opportunity to "pierce the corporate veil," thereby holding the shareholders themselves liable if certain circumstances exist with respect to their relationship to the corporate entity. In other words, a plaintiff can potentially go after your personal assets (your house, your bank accounts, etc.) for the negligent acts of the corporation.
The circumstances in which Pennsylvania allows plaintiffs to pierce the veil are multiple, but the most common three factors that I have seen courts use against the shareholders of a corporation are the following: commingling of personal and business funds, undercapitalization or underinsuring of a small business, and failure to follow corporate formalities. Courts, when faced with a plaintiff who names the shareholders of a small business individually for the liabilities of a corporate act, will look to see if any or all of those factors exist in the shareholders relationship to the corporation, and, if they do, will often allow the plaintiff to proceed in the litigation against the individual shareholders.
How do you protect yourself? Don't allow your relationship with your small business to meet any of those three factors.
1) Never, EVER mix your business funds with your personal funds. Courts will look at this factor first, and if it exists, may be prone to believe that the corporate existence is nothing more than a sham to protect an individual from liability. Keep your accounts concrete and separate -- do not deposit checks owed to your business into your own bank account.
2) If your business has physical property that could somehow cause an injury or involves labor that could cause injury, then be sure that you are well-capitalized and well-insured to be able to compensate an injured individual (if you are a contractor or construction firm, you will obviously need more insurance than a internet start-up). Keep up-to-date liability insurance on your real property. Make sure you carry general liability insurance. Be sure that your business is capitalized well enough that it can keep up with its contracts and debt payments.
3) Observe corporate formalities (even when it seems silly to do so). A good business, even one with a sole shareholder, keeps corporate meetings, elects board members (even if there is only one) and keeps minutes. Closely held businesses and sole-shareholder corporations may find this a waste of time -- but dotting the i's and crossing the t's keeps shareholders safe and makes for responsible businesses that can keep up with their debts and meet legal liabilities.
As always, if you are a small business in the Pittsburgh area in need of legal advice, call my office for a free consultation. (412) 246-2023.
Peter H. Kurzweg, Esq.
Thursday, October 30, 2008
Tuesday, October 28, 2008
Why Your Business (No Matter How Small) Needs a Lawyer for its Formation
When you're first starting a new business, it's tempting to attempt to cut costs wherever possible, especially when you're starting a new business with less than ideal capitalization. Unfortunately, as I have seen all too often in my experience representing my clients, one of the first places small businesses try to cut start-up costs is in avoiding legal fees in the creation of their business. These businesses instead rely on one of the countless versions of the "do-it-yourself" legal books sold to starry-eyed entrepreneurs trying to cut-costs in the short term, and already reaping long term windfall profits in their own minds. Many of these businesses do indeed attain some level of success, only to walk into my office for the first time with a costly legal crisis that could have been avoided had they hired me in the outset of their business.
So what does a good lawyer do when he's starting your company that you wouldn't do yourself?
Simply put, a good lawyer does four things: a good lawyer 1) listens to your business plan, 2) asks you questions that you have not thought to ask yourself, 3)creates consensus and understanding among all of the principals involved in the creation of the company, and 4) translates all of these concepts into sound legal documents that encompass and protect the parties' expectations and relationships and provide for both the possibility of the company's growth or the company's termination.
I'll further explain these points one at a time.
1. A good lawyer listens: When you and your business partners first visit my office for a free consultation, the first item of business will be for you to explain to me what it is that you want your business to do, how you wish to do it, and what you expect from each other in meeting your business goals. This gives me an overall sense of what type of business you wish to create and what type of personalities are going to be involved. After passively listening and taking notes, I then become active in the process.
2. A good lawyers knows what questions to ask: The most central role of the lawyer in helping form a new business is to make sure that the articles and bylaws (and other documents depending on the choice of corporate entity) of the business reflect the intentions and expectations of the principals. And to create such documents, the lawyer not only must thoroughly understand these intentions and expectations himself, but he must also make sure that the principals fully understand their own intentions and expectations. In other words, many times a good lawyer must ask the questions that the principals have not thought of, or are afraid to discuss. From my experience, there are two things that are true for almost every small business when first getting off the ground: the principals rarely discuss the possibility of the business's failure and the principals rarely discuss problems that they have with each other, or their role. If the business plan isn't working, we must discuss how the principals wish to close the business's doors, if there is an escape plan for the individual shareholders if other shareholders wish to carry-on, the priority in which principals will be paid or reimbursed from the sale of any assets, and a laundry list of other rather depressing scenarios that new business partners don't wish to discuss with each other because they are, frankly, rather socially uncomfortable. Which brings me to the third point.
3) A good lawyer gets all of the principals on the same page: In small, closely owned businesses, shareholders often double as directors and officers. There are inherent conflicts that can arise from this situation, which are best remedied by careful legal planning at the outset of the formation that will be reflected in the By-Laws or Operating Agreement of the company. Principals also need to know what their expectations of each other are. If a shareholder is putting sweat equity into the corporation, do the passive investors who are only investing capital expect him to have greater or lesser equity than themselves? How will the shareholders and directors control the company? How is voting to be conducted? Will minority shareholders have a voice in electing directors? Again, there are a laundry list of questions, the answers to which highly affect the principals and the shareholders relationships to each other, that if not addressed until a problem arises can become very costly to the corporation.
4) A good lawyer is an interpreter: Finally, at the end of our meeting, if the client chooses to retain me, I ultimately act as an interpreter who takes all of the input that I received from the client, and generates legal documents that reflect this input, ultimately reflecting the intentions and the expectations of the parties with regard to what they want to happen if the corporation is successful and what they wish to happen if the corporation is not successful. It is these documents, which have been custom built for your business (and not generated by a computer program or form book), that will provide your business with legal stability down the road.
All of this help may look expensive, but it can be affordable through the use of flat fees or discounted-rate billing. For a free consultation for your small business, please visit my website or call (412) 246-2023 to speak with me and set up an appointment.
Peter H. Kurzweg, Esquire
So what does a good lawyer do when he's starting your company that you wouldn't do yourself?
Simply put, a good lawyer does four things: a good lawyer 1) listens to your business plan, 2) asks you questions that you have not thought to ask yourself, 3)creates consensus and understanding among all of the principals involved in the creation of the company, and 4) translates all of these concepts into sound legal documents that encompass and protect the parties' expectations and relationships and provide for both the possibility of the company's growth or the company's termination.
I'll further explain these points one at a time.
1. A good lawyer listens: When you and your business partners first visit my office for a free consultation, the first item of business will be for you to explain to me what it is that you want your business to do, how you wish to do it, and what you expect from each other in meeting your business goals. This gives me an overall sense of what type of business you wish to create and what type of personalities are going to be involved. After passively listening and taking notes, I then become active in the process.
2. A good lawyers knows what questions to ask: The most central role of the lawyer in helping form a new business is to make sure that the articles and bylaws (and other documents depending on the choice of corporate entity) of the business reflect the intentions and expectations of the principals. And to create such documents, the lawyer not only must thoroughly understand these intentions and expectations himself, but he must also make sure that the principals fully understand their own intentions and expectations. In other words, many times a good lawyer must ask the questions that the principals have not thought of, or are afraid to discuss. From my experience, there are two things that are true for almost every small business when first getting off the ground: the principals rarely discuss the possibility of the business's failure and the principals rarely discuss problems that they have with each other, or their role. If the business plan isn't working, we must discuss how the principals wish to close the business's doors, if there is an escape plan for the individual shareholders if other shareholders wish to carry-on, the priority in which principals will be paid or reimbursed from the sale of any assets, and a laundry list of other rather depressing scenarios that new business partners don't wish to discuss with each other because they are, frankly, rather socially uncomfortable. Which brings me to the third point.
3) A good lawyer gets all of the principals on the same page: In small, closely owned businesses, shareholders often double as directors and officers. There are inherent conflicts that can arise from this situation, which are best remedied by careful legal planning at the outset of the formation that will be reflected in the By-Laws or Operating Agreement of the company. Principals also need to know what their expectations of each other are. If a shareholder is putting sweat equity into the corporation, do the passive investors who are only investing capital expect him to have greater or lesser equity than themselves? How will the shareholders and directors control the company? How is voting to be conducted? Will minority shareholders have a voice in electing directors? Again, there are a laundry list of questions, the answers to which highly affect the principals and the shareholders relationships to each other, that if not addressed until a problem arises can become very costly to the corporation.
4) A good lawyer is an interpreter: Finally, at the end of our meeting, if the client chooses to retain me, I ultimately act as an interpreter who takes all of the input that I received from the client, and generates legal documents that reflect this input, ultimately reflecting the intentions and the expectations of the parties with regard to what they want to happen if the corporation is successful and what they wish to happen if the corporation is not successful. It is these documents, which have been custom built for your business (and not generated by a computer program or form book), that will provide your business with legal stability down the road.
All of this help may look expensive, but it can be affordable through the use of flat fees or discounted-rate billing. For a free consultation for your small business, please visit my website or call (412) 246-2023 to speak with me and set up an appointment.
Peter H. Kurzweg, Esquire
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