Thinking of starting your own business with your money? What you need is a willingness to learn. There are countless business books out there and, while many are not exciting to read, virtually all of them will have a point or two that you can use.
I was recently reminded of a favorite business story: an uneducated man opens a shoe store. He becomes very successful over the years and is so successful that he sends his two sons to Harvard Business School. Upon graduation, the sons decide to open a shoe store across the street from the old man. Within six months, the sons go bankrupt. Approaching their father, they ask “Dad, you have no education and we went to Harvard Business School. How did you put us out of business in only six months—what is your secret?”
The old man replies: “I don’t know. I buy the shoes for $5, I sell them for $10 and who cares if I only make one percent?”
Who doesn’t love that one? It points out a truth: you do not need a business degree to succeed in business.
However, if you are considering opening your own business, or if you already have one and are looking to become more successful, you need to know the language.
Let’s start at the beginning with types of businesses.
Many are “sole proprietorships.” That means that the person owning the business is not incorporated but is running a business as their alter ego, with all profits and losses running through that person’s personal tax return. The problem with this form of business is liability. If someone sues a sole proprietorship, they are suing the person and all the assets of that person. The sole proprietor has no protection for his or her assets.
I always advise my clients to look to the “parade of imaginary horribles.” That means thinking of every possible thing that can go wrong and planning against it. Think no one could possible sue your sole proprietor business? Think again. These days, lawsuits are so common over anything that you can never say you are immune from suit.
Given this potential liability, what do you do?
There are forms of businesses that will protect your personal assets from liability — these are “corporations”, some “partnerships” and limited liability companies (LLCs), which are combinations of corporations and partnerships. Once you legally set up a corporation, partnership or LLC, and someone sues, they sue the corporation, the partnership and the LLC, not you personally. And, if they win, the assets available to them are from the corporation, partnership or LLC, not you. They cannot touch your personal assets unless you have acted in such a way that the corporation, partnership or LLC structure can be attacked. Creating a legal vehicle for your business is a form of liability protection to your personal assets.
These days, the two most common legal vehicles for small businesses are the LLC and the “Subchapter S Corporation” (the Sub-S). Both of these vehicles allow for the pass-through of the businesses’ profits and losses to the owner in the same way the sole proprietorship works. In these cases, however, because you are setting up a separate legal entity, your personal liability vanishes and the entity, whether it is a LLC or a Subchapter S corporation, retains the liability.
So, you have decided to create a business and now you have to decide whether that business is an LLC or a Sub-S.
An LLC is created by filing Articles of Organization with the State. LLCs may, but do not have to have, an Operating Agreement. The Operating Agreement is a document between the Owner of the LLC and the LLC setting forth the duties and responsibilities of the Owner. I like to see written Operating Agreements for LLCs, including sole owner LLCs, since at the very least, they provide an indication that the business is separate from the Owner. Of course, Operating Agreements become very important if there is more than one Owner. One size does not fit all when dealing with Operating Agreements.
I recently had a woman come to me to amend her Operating Agreement. Unfortunately for her, she had purchased the Operating Agreement from an online service and, not surprisingly, when I looked at what she had purchased, it was completely inadequate for her purposes. She had an Operating Agreement for a sole owner, not an agreement for a partnership. There was nothing in her boilerplate agreement to cover the situation where a partner dies or is disabled. Why is this important? Because, if her partner dies or becomes disabled, she could end up with the partner’s wife or children as her new partners. To avoid that, the Operating Agreement had to address what does happen on death or disability of a partner —my client’s choice was to buy out the partner’s interest in the business upon death or disability.
About the Author: Lyn Striegel is an attorney in private practice in Chesapeake Beach and Annapolis. Lyn has over thirty years experience in the fields of estate and financial planning and is the author of “Live Secure: Estate and Financial Planning for Women and the Men Who Love Them (2011 ed.).” Nothing in this article constitutes specific legal or financial advice and readers are advised to consult their own counsel.