Posts Tagged ‘business owners’

Personal Liability For Business Debt: The Protection Of A Corporation Is Not Automatic

June 16, 2014

pierce corporate veil

A key reason that business owners and shareholders choose to form a business as a corporation or limited liability company (LLC) is the protection from personal liability for business debt that is afforded those business types. Corporations and LLCs exist separately from their owners as do the assets and liabilities of those entities. But the protection from personal liability is not automatic. Business owners have a responsibility to show that the business operates independently from its owners. Failing to do so puts the owners at risk that a creditor may be able to disregard the company as a separate legal entity, and impose personal liability upon the entity’s owners, shareholders or members. This process of seeking to hold owners personally responsible for the debts of the business entity is known as “piercing the corporate veil.” When this happens, the owners’ personal assets can be used to satisfy business debts and liabilities. This means creditors can go after the owner’s home, bank account, investments, and other assets to satisfy the corporate debt. To ensure the protection of a corporation or LLC remains intact business processes must be in place to demonstrate the separation a business entity from its owners. At the inception of a business and then continuing during the life of a business, processes must be proactively managed to avoid situations which could cause the corporate veil to be pierced. Consider the most common factors courts use in determining whether to pierce the corporate veil:

Following Corporate Formalities:  Corporations have strict formalities they must follow, and while LLCs do not face the same requirements, many of the same steps are advisable. Small corporations are less likely than their larger counterparts to observe corporate formalities, which makes them more vulnerable to a piercing of their corporate veil. It’s important for small corporations and LLCs to comply with the rules governing formation and maintenance of a corporation and to maintain proof of compliance, as follows:

Corporations
• Create and regularly update bylaws
• Issue shares of stock to owners (shareholders) and maintain a stock transfer ledger
• Hold both an initial and then annual meetings of both directors and shareholders
• Undertake any annual filings required by the state of incorporation in a timely manner
• Pay the necessary filing fees and corporate taxes

LLCs
• Undertake any annual filings required by the state of incorporation in a timely manner
• Pay the necessary filing fees
• Create and regularly update an operating agreement
• Issue membership certificates to owners
• Keep a membership transfer ledger
• Hold both initial and then annual meetings of the members and managers
In both instances the organization must ensure that officers, agents, or members abide by the requirements of either the bylaws or operating agreement.

Ensuring Adequate Capitalization:  A business requires money and the equipment and items necessary both to start and continue operations. There are several sources of funds for business operations: capital contributions from business owners, investments from others and business loans. Whatever the approach, without adequate capital, a business will not survive. (Also keep in mind, this capital needs to be designated to the business and not the business owner.) There is no requirement that a corporation or LLC be flush with cash in order to preserve its limited liability, but it is necessary to have sufficient funds so that creditors are not left with uncollectible invoices due to a customer’s irresponsible overspending. Typically, courts recognize that cash flow problems can and do occur and will allow a creditor to pierce the corporate veil only if it is determined that the entity was “grossly undercapitalized” at the time the debt was incurred. This means that taking on significant debt at a time when a company can’t meet its current obligations puts it at risk that a creditor may be able to look to the individual shareholders for payment. Starting a large project or purchasing supplies or inventory with the knowledge that the business cannot pay the related debt increases the likelihood that a court will permit the company’s veil to be pierced.

Maintaining Separation Of Business And Personal Assets:   Small-business owners may be more likely than their larger counterparts to intermingle their personal assets with those of the corporation or LLC. Some small-business owners divert corporate assets for their own personal use by writing a check from the company account to make a payment on a personal obligation or by depositing a check made payable to the corporation into the owner’s personal bank account. This is called “commingling of assets.” A business owner may find it is easier to pay personal bills from a business account rather than write one check to cover the owner’s salary and then a second check from the owner’s account to pay a bill. Regularly following this practice could allow a creditor to pierce the corporate veil, particularly when the owner’s scheduled salary or draw is not enough to cover personal bills. To ensure that business and personal assets remain separate, the corporation should maintain its own bank account and the owner should never use the company account for personal use or deposit checks payable to the company in a personal account. Likewise, a business credit card should be used for business expenses only.

Inadequate processes are not the only reason the corporate veil may be pierced to satisfy a creditor’s claim. Business owners or shareholders may lose the insulation from personal liability for business debt if a court finds that the company’s actions were wrongful or fraudulent. If the owners recklessly borrowed and lost money, made business deals knowing the business couldn’t pay the invoices, or otherwise acted recklessly or dishonestly, a court could find financial fraud was perpetrated and that the limited liability protection shouldn’t apply.

C3 Advisors, LLC
June 16, 2014

C3 Advisors converges the three essential business elements—Process, People and Technology—to help businesses thrive, not just survive, by improving profitability and reducing risk. Our services help our clients improve process optimization, people integration and technology maximization.
Process Optimization focuses on establishing formalized operational functions that facilitate increased productivity, mitigate risk, and provide the foundation for optimal profitability.
People Integration addresses staffing and workforce issues that are critical to the success of continually cost efficient, low risk, and productive processes.
Technology Maximization ensures the ROI on a technology investment is fully realized through complete use of systems functionality and business intelligence.

We have specific expertise in post-acute healthcare, technology and service companies. Please visit our website at http://www.c3advisors.com and for direct information about how C3 Advisors, LLC can assist your business, please call us at (630) 510-3181 or e-mail us at debd@c3advisors.com.
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Combining Cultures: Business Sale Success Depends on People

June 17, 2013

new managementThe sale of a business always has implications for the seller and employees of the company being sold.  In some cases, employees will lose their jobs, while in others, they will have a new boss, new policies and procedures to follow, and new expectations.  An owner may have to make the transition from entrepreneur to employee.  The ease or difficulty of making the transition to new roles and reality, depends on the seller’s preparation for the hand-off to the new owner and the new team’s integration strategy.

How Will the Seller Fit In After the Sale?

A seller’s knowledge of his business is often critical to the continued success of the company, and for that reason, the seller’s role after the sale is a significant negotiating factor.  Sellers are kept on to help the new owners reach their goals, but typically without the control they are accustomed to.  It can be frustrating when new management ignores advice or overrules a decision.  Making the mental switch to being employee on a team can be very challenging for an entrepreneur who has had deep involvement with the management of operations, staff and customers.   The best way to overcome the pitfalls of this situation is to negotiate well and be prepared to play by someone else’s rules.   Compensation, vacation time, how long the seller is required to stay on,  revenue goals and decision-making authority should all be addressed in the contract.  Even when the seller believes there is clarity on how he will fit into the new owner’s plans, there are often surprises.    For this reason, a seller may decide not to be part of the transition and accept a lower sales price rather than work for someone else.

What Will Happen to Employees?

Often one of the trickiest aspects of a business sale is what will happen to the company’s employees.  Most business owners realize the professional and personal loyalty they owe to their employees.  After all, the success of the business would not have been possible without their hard work.   As a general rule, employees’ jobs are secure in a small business sale.  Smart buyers know that the ongoing success of and profitability of the business is highly dependent on the company’s employees who typically wear many hats and perform a variety of tasks that ensure operations run smoothly.  Additionally, they are intimate with customers and suppliers and have built solid relationships in these areas that are vital to the competitive advantage of a prosperous business.  A new owner is most likely to keep employees if the seller has taken steps to ensure the company team is working at their highest level even before an owner looks for a sales opportunity.  Lean, efficient operations reduce the likelihood that headcount will be trimmed after a business sale.  Developing a solid management structure that requires accountability will provide the new owner with a team who can make decisions in the absence of the seller.

But when and how to disclose a pending sale to employees can be one of the most difficult decisions a seller must make.  Business owners and experts are divided on the best approach to take when it comes to addressing the subject with employees.   Some assert transparency throughout the process is the wise choice, while others contend that revealing sales intentions to employees will adversely affect the outcome of the sale.  Here is a look at both options.

Keep People Informed

The rationale for this course of action is that the nature of business sales negotiations make it nearly impossible to keep them a secret.  It does not take long for employees to realize that a sale is planned.  Rather than risk rumors which cause a mass exodus, morale problems, distractions which impact productivity, or unnecessary stress on staff, an open-book culture will allay employees’ concerns and keep them engaged in their work.  The likelihood of a successful sale increases if the owner can assure the buyer that the team will remain intact.  Such guarantees are not possible if employees are kept in the dark.  Additionally, an owner can emphasize that consistent high quality work will encourage the new owner to keep staff after the sale. 

Keep Plans Quiet

·        News of a possible sale can cause confusion, anxiety and staff departures.  Sales negotiations are far too volatile and discussing a deal with employees can put them on a roller coaster when things fall apart at the last minute.  The length of time it takes to complete a sale—2 years is not uncommon—can create a long period of uncertainty.  If a large number of employees or key individuals leave during sales negotiations, the buyer may walk away, or the seller may have to accept a lower sales price.  Another risk of disclosing sales plans is that employees may tell customers about it.  Apprehension about the changes may trigger the loss of business at the time when it is most important to keep sales strong.

Successful businesses typically have key employees who would need to stay on to assure a smooth transfer of ownership.  Sharing confidential information with these individuals about the sale is necessary in order to provide assurances to the buyer that the knowledge and skills of these employees will remain with the company, for at least a period of time.  Retaining these employees is a point of negotiation with the seller who can offer bonuses and compensation packages to encourage employees to work for the new owner.  Creative retention plans that provide incentives for employees to stay on through the transition period reduce the risk of declining morale, decreased productivity, loss of employees, and possibly, customers.   The seller must use his best judgment as to the ideal time to bring these employees into the confidence of sales discussions.

Even when the buyer shares his staffing plans during the sales process, the eventual outcome may be different than what was contemplated.  Some employees may lose their jobs, or the new owner may bring in new employees.  It is up to the buyer to manage the integration of all employees into the new culture.  A seller and his employees who continue to work for the new owner should be prepared for change.

This is Part IV of a four part series on selling a business.  Read C3 Advisors’ blog for Part I: Build for the Buyer, Part II: Process Pays and Part II:  Tax Tactics.

Learn more about C3 Advisors, LLC at www.c3advisors.com.  Find us on Facebook and LinkedIn.  Subscribe to our newsletter by emailing debd@c3advisors.com.