What is an entity?
In the eyes of the law, an entity is a person that is separate from other businesses or individuals. An entity is a business, and it allows the business to act as its own person outside the direct connection to the owner. Legal entity formation is the business equivalent to giving birth. When a child is born, they are established as their own individual; when an entity is formed, it is established as its own person.
Why are entities important?
An entity separates the accountability of the business from the owner. It creates a wall between the business’ assets and the owner’s assets because they are both considered their own person in the eyes of the law. Therefore, the business is not responsible for the owner’s responsibilities and importantly, the owner is not liable for the business’ responsibilities.
This is critical because if a business owes money to another party, such as a fine, the party can only collect the assets that are associated with the entity, rather than have access to the owner’s assets.
If you own and operate a construction company, your business needs to be set up as an entity in order to protect your assets from your business’ accountabilities.
LLC vs Corporations
The two most common entity formations are an LLC and a corporation. When creating your construction business or forming your entity, you must determine which type of entity your company will be.
There are multiple ways in which these two differ, some differences are discussed later, but the best way to determine which is best for your business is consulting with your entity formation attorney and CPA. MNCLS can help guide you through this process.
Once your entity is formed, it’s time to start protecting it!
How to Protect Your Entity
In the law, there is something called “piercing the corporate veil.” This is the process of breaking the wall between the entity and the owner in order to collect on the owner’s assets. Forming an entity will create the initial wall, but it will only remain unbreakable if the owner follows the formalities of the entity. There are certain laws and regulations an entity must follow to uphold its status in the law.
If you are not following the formalities of your entity, then it removes the wall of defense thus allowing your personal assets to become liable for your business’ repayments. To secure your entity, you must implement and follow the legal procedures. Below are 4 ways you can protect your entity and safeguard your assets.
1. Don’t Commingle Assets
Since the business and business owner are considered two different people according to the law, one’s assets cannot be used for the other’s purposes.
For example, if an owner is driving home from work on Friday evening and stops at the grocery store to pick up pizza and soda for the family they cannot use the company’s credit card. The company’s money should not be used by the owner for personal use no matter how small or large the purchase may seem.
If the business’ money or assets are being used by the owner for personal purchases, it breaks that entity wall and creates a costly hole in the defense.
2. Create Partnership Documents
Whether you are an LLC and your partner is considered a member or you are a corporation with shareholders, your entity needs to have proper documentation of your partnership(s). You need to clearly outline the roles and responsibilities of the involved partners and how the management team runs the business. This creates a layer of protection for the entity because it demonstrates to the law that the entity is being operated by an individual or group as it’s own person, rather than an extension of an owner’s assets.
3. Follow the Proper Decision-Making Process
Whether you have a dozen partners, a handful, or just yourself, you need to follow the proper decision-making processes for your entity. Two processes to follow are holding an annual board of directors meetings and authorizing purchases.
Again, if you have multiple members of the board or it is just yourself, to comply with regulations you need to hold an annual meeting to consider and approve the company’s activity and plans for the following year. Importantly, these meetings need to be documented, called annual meeting minutes, to provide legal documents and proof of your compliance.
If you are making a large purchase for the company outside of ordinary operations, the purchase needs to be authorized by the board of directors. The necessary documents need to be recorded to show the legal authorization for making a purchase for the entity.
While these decision-making processes may seem redundant, especially if you are the sole partner, they follow the formalities that protect your entity and uphold the strong wall between your assets and your business.
4. Renew your entity each year
While entity formation is like birthing a child in the eyes of the state, unlike a child, you must renew your entity every year. Essentially you are telling the state that your entity is still up and going. It maintains the entity’s legal status.
It’s the end of the year, which means two things:
1. Renew your entity with the state
You can renew your LLC or corporation entity by visiting the Minnesota Secretary of State website.
2. Complete your annual company minutes
MNCLS provides a quick intake form for creating annual company minutes for your business. Simply input your company’s information and we will create the annual company minutes for your records.
If you have questions or want more information regarding the topics discussed in this post/article, please reach out to MNCLS.