Let’s start off by going over some terminology regarding LLCs. An LLC (Limited Liability Company) is owned by its members. The LLC can be owned by a single member (one person or entity) or multiple members (several people). In contrast, a corporation is owned by its shareholders. In a corporation, shareholders must conduct yearly formal meetings and keep a record of the decisions in a document that is referred to as the meeting minutes. They also must create operating bylaws. These types of meetings are not required for LLCs.
Liability Protection
Many entrepreneurs form an LLC to shield their personal assets from confiscation in the case of a lawsuit. However, there are instances when your personal assets are at risk. This is called “piercing the corporate veil”. That is why it is necessary to complete a few steps to ensure that your personal assets are protected.
8 Common Mistakes That LLC Owners Make
1. Not Having An Operating Agreement For Your LLC
This step is not required, but strongly encouraged.
The operating agreement contains details such as
- how you will run the LLC
- if you are planning to buy property for the LLC.
- How you will take a salary
- The type of business activity that you will be engaged in.
- Insurance and permits that would be required for the business.
- The location of the business.
- What happens if the business is dissolved.
- Any startup investment you will contribute to the business.
- Add any relevant information that defines the business
This may seem like a lot of details, especially if you work for yourself. However, an operating agreement helps define your business. In the event of a lawsuit, the operating agreement will add a layer of protection because it clearly delineates the activities of your business activities. In the event of a lawsuit, it is less likely that your personal affairs become entangled with your business affairs if you have a detailed operating agreement in place.
2. Not Recording Meeting Minutes For LLCs
This step is not required, but strongly encouraged.
Meetings should be conducted at least once a year. Record the time, date and place where the meeting takes place. Make a note of any major purchases, investments, changes in membership structure and any major changes in the business model. Keep the notes, referred to as the meeting minutes together with your LLC’s other important documents.
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You can produce “meeting minutes” even if you are a single-member LLC. In this case, it is more like an annual report and is very useful to track the evolution of your business.
Record major purchases in a notebook or text file. The note can include justification for the purchase, such as a new printer, vehicle, microphone etc.
3. Failing To Do Timely Bookkeeping For LLC
Keep a clear record of revenue and expenses so that when tax time comes around, you won’t get overwhelmed. Timely bookkeeping lessens the chance of forgetting to account for a revenue or expense item. So, if you need to justify a transaction during a tax audit, you’ll have clear bookkeeping records to back you up. You can use an online service like Quickbooks to help you keep track of monthly revenue and expenses.
4. Business Account For LLC
A business bank account is crucial to help keep your finances separate. Failing to keep your personal and business accounts separate might make it easier to pierce the corporate veil in the case of litigation.
You will need an EIN number in order to open a business bank account. An EIN number is free to obtain from the IRS.
There are certain procedures to follow if you want to pay yourself or make a capital contribution to the LLC.
5. Make sure the business is properly capitalized
The more transactions there are between your personal and business bank accounts, the higher the likelihood that the corporate veil can be pierced during litigation. Ensure that the LLCs business account has sufficient cash flow to handle at least three months of operating expenses.
A common mistake is to withdraw money from the business account as soon as it is deposited from your different sources of revenue.
6. Sign as the LLC when making contracts
If you take out a new lease for office space, write down the LLC as the entity that space is being rented to. Sign with your personal signature as the member/owner of the LLC.
The correct format for this would by [Business Name] LLC by [Member’s Name] Owner
7. Avoid mixing personal and business funds
Apart from funding your business for cash flow with your personal assets and paying yourself a salary, you shouldn’t have any other transactions going to and from your personal bank account to your LLCs business account. Don’t use your business bank account for non-business purposes like paying for your personal car payment, and internet subscriptions for personal use such as Netflix.
8. Liability Insurance
Liability Insurance for LLCs adds a layer of protection to your personal and company assets. If you are sued, the insurance company will be able to cover the amount that is established in your insurance policy.
The Alter Ego Doctrine
Is the LLC just an alter ego of its owner or is it a separate legal entity?
If you make any of the mistakes mentioned above, then the LLC might be regarded as your “alter ego” during a court case. The court may find this to be true if the LLC lacks a separate identity. Finding an “alter ego” to be present enables the court to pierce the corporate veil and hold the owner(s) personally responsible for the debts. This avoids an unjust situation for creditors.
Create Separateness
You should aim to create the highest degree of separation between you and your company. Following the formalities normally reserved for corporations will add more layers of protection between the LLC and your personal assets.
