Let’s be clear; I’m not talking about etiquette or outdated social customs.
What I’m referring to are legal formalities you’re required to observe for your business, that is if you want to keep the protection provided to you by your business structure.
So, do you know which formalities you need to follow for your business structure? But more importantly, do you follow them?
Too many business owners either are not aware of the formalities, have forgotten about them, or just don’t pay attention. But not you, once you’ve finished reading this article!
So let’s start with looking at:
- What are legal formalities?
- Who needs to follow them?
What are they?
There’s no surprise here.
When it comes to starting and operating your business, there are formalities you must follow to be recognized and qualify as a legal entity, like an LLC or Corporation.
Some formalities are one-time, others may be reoccurring. Here are a few examples of legal formalities:
- Certificate of organization
- Articles of incorporation
- Operating Agreements
- Annual meetings
- Minutes of meetings
- Annual state filing
Who must follow them?
The legal formalities you’re required to follow depend on your business entity and your location. Different states have different requirements.
Typically, you can find state-specific information by going to the website of the Secretary of State for your state.
Now, not all types of business must observe formalities.
For example, if you operate as a sole proprietor or general partnership (not advised!), there are no start-up or ongoing formalities, such as state filing or meetings, that you must follow.
However, if structured as an LLC or a Corporation, there are several formalities you must follow, most commonly annual filings and meetings.
Be sure to check your state for specific requirements.
Why Do Formalities Matter?
Since we don’t often hear about business formalities, it may seem they are not important.
But they are!
What happens if you ignore, or don’t follow the formalities? Probably not much initially…
However, at some point, you could end up with fines and late fees or losing the protection your entity provides for you.
Let’s look at an example…
Let’s say your practice is structured as an LLC, and someone decides to sue you.
Your business is a standalone legal entity, separate from you, the owner. Generally, the owner is not personally liable for the liabilities and actions of the company.
If the party suing can show your business doesn’t operate like an LLC, they may be able to pierce “the corporate veil,” which refers to the separation between you the individual, and the business.
Essentially, you could lose the protection the LLC affords you and become personally liable for the actions of your business.
As the name “corporate veil” implies, there’s a thin separation between individual and business that must be kept intact.
Different legal structures call for various formalities that must be followed to maintain the benefits and protection the entity provides. And that’s why you must observe the legal formalities required for your business entity.
Suffice it to say, corporate structures and formalities will not protect if there are fraud or illegal activity at play!
But as long as laws and rules are followed, and requirements are observed, they do provide protection.
Most of the legal formalities required are simple and easy to follow. Could that be the reason why so many forget about them?
So, to maintain the protection of your legal structure, make sure you follow all formal requirements, such as…
- File all reports as required
- Hold annual meetings (even if with only with yourself)
- Document the meeting in the minutes
But beyond the legal formalities, there is one more step to help maintain the separation between you and your business.
From the very start, maintain separate financial accounts and records for your business and yourself. And do not co-mingle between the two.
Use separate credit cards for business and yourself and don’t co-mingle.
Money taken from the business by you must be clearly identified; check with an accounting professional for how to do this.
Ideally, you would obtain loans and leases under the name of your business. However, frequently, the owners of new businesses are asked to provide a personal guarantee.
Maintaining the separation between your business and personal finances is critical. Unfortunately, too many small business owners ignore this basic principle.
If you find yourself mixing business and personal finances, stop doing it! Mixing personal and business finances could land you in a lot to trouble!
Get separate checking accounts, credit cards, debit cards, and use them as such!
It’s not enough to pick a legal structure with the potential to shield you from personal liability. Beyond that, you must operate within the law and follow all required legal formalities to keep the protection of your legal entity intact.
Stay on top of all state requirements; know and understand all formalities for your entity. File all documents complete and on time.
Conduct and document all necessary meetings, even if you’re a single-member LLC. In most cases, required formalities are straightforward and easy to fulfill.
And pay attention to the day-to-day financial details. Keep separate checking account and do not co-mingle funds.
Now for the record…
I am not an attorney. The information in this article is informational in nature and not meant to replace proper legal counsel.
Please consult with a legal professional to get appropriate input and guidance for your specific situation.
Did you remember the necessary “formalities” for your business? Share your experience with your community; just leave your thoughts below.
By Johanna Hofmann, MBA, LAc; regular contributor to the NPBusiness blog and author of “Smart Business Planning for Clinicians.“