Using the Proper Business Entity is Good Business

By: Nathan M. Brandenburg, Esq.

Why go to the trouble of forming a corporate entity for your business or investment real estate? It is a basic, yet very important question. The answer, in its simplest form, is to protect your personal assets from your business interests and to protect your business interests from your personal assets.

The two most prevalent forms of corporate entities are the corporation and the limited liability company (“LLC”). Although various forms of limited partnerships exist and continue to serve useful purposes, the use of limited partnerships has decreased dramatically since Minnesota formally recognized LLCs in the 1990’s.

How a corporate entity is formed

Forming a corporate entity begins with drafting Articles of Incorporation (for corporations) or Organization (for LLCs) and filing the Articles with the Minnesota Secretary of State. (Although the Secretary of State offers certain standard forms for the formation of a corporate entity, we generally do not recommend the use of such forms as they rely upon undesirable default provisions of the Minnesota Business Corporation Act and Limited Liability Company Act. In other words, “you might get what you pay for.”) Upon the Secretary of State’s acceptance of the Articles, the corporate entity is “alive”; in essence, the act of filing has created a legal person.

To ensure that the entity provides the liability protection it is designed to provide, certain documents are necessary to ensure that the entity maintains a legal presence that is separate and distinct from its owners. These documents include Bylaws (for corporations) or an Operating Agreement (for LLCs), written board authorizations electing directors (for corporations) or governors (for LLCs) and officers (for corporations) or managers (for LLCs), and Subscription and Investment Agreements. Further, if an entity has more than one owner who are not husband and wife, a Shareholder or Member Control Agreement is recommended. These documents are designed to create certain formalities that ensure that the corporate entity operates as a separate and distinct business and not merely as an extension of its owners. The most important facet of this separation is ensuring that decisions by the corporate entity are properly authorized by the entity’s management and that a strict separation of business and personal funds is maintained.

What does an entity provide?

A corporate entity provides liability protection. The last thing you want is for a dispute that arises out of a business transaction to result in a lawsuit and a potential judgment against you that will also attach to your home, your bank accounts, your automobiles, etc. Hence, a lawsuit against your business—provided proper corporate formalities are maintained—should only affect your business and not result in a lien against your personal residence or garnishment of your personal savings, other employment income or your automobile(s). Likewise, with careful planning, a lawsuit against you personally should not attach to your business interests.

Separation of business interests

The separation of different business interests into different entities is as important as the separation of personal and business interests. Hence, it is extremely important that each business operate through its own entity and maintain a strict separation of finances. For example, a corporate entity should always maintain its own bank account and not operate out of the personal accounts of its owners.

Investment Real Estate

Investment real estate includes any real estate you own other than your home, including a cabin. The ownership of such property constitutes a business interest that is separate and distinct from your homestead and deserves the protection of a corporate entity. Should the unthinkable happen and you are faced with a lawsuit that results in a judgment against you personally, thus becoming a lien upon your home, an LLC can help protect your other real estate from the reaches of a judgment creditor. Hence, you will not have to worry about your cabin—which you had planned to will to your heirs—becoming the new cabin of the judgment creditor.

Costs

The cost of forming and maintaining a corporate entity is minimal in comparison to making the wrong decision or no decision. The initial expense of forming a corporate entity is often not much more than the cost of the yearly automobile insurance premium. Given the potential dangers that lurk in our ever-litigious society, it is a rather inexpensive insurance policy and should be considered a part of the cost of doing business.