Why Every Entrepreneur Needs A Legal Entity

Imagine this… you have recently completed your course work and have just received your certification as a Nutritional Therapy Practitioner.

Excitedly, you want to start dipping your toe in the water and take on your first few clients of your own to start advising them on nutritional issues. While you work on building your business, you keep your primary job as an account manager at a local marketing company.

For the time being, your nutrition business seeing a few one-off clients is just a side hustle, right? So, you decide you do not need to go through the time or expense of formalizing your business, and speaking to a lawyer about forming an entity… well, that just sounds intimidating, expensive, and unnecessary.

A few months later, you are served with a lawsuit seeking damages in excess of $100,000 plus recovery of attorney’s fees (which trust me, are never cheap). Upon further review of the paperwork, you find that the lawsuit alleges you were negligent in providing services to one of your very first clients that you took on in your “side hustle”, and she is now suffering from a debilitating medical condition that she claims was made worse due to your negligent nutritional and supplement recommendations.

Suddenly, you feel scared. Your side business, which was only generating a couple of thousand dollars a month in income, has now opened you up to more than $100,000+ of potential exposure.

If this client were to prevail, you would be expected to pay that judgment from any assets you have (including any savings, homes, cars, or 401(k) balance you may have, depending on what state you are in). You are filled with regret and anxiety, and the reality is that this could financially cripple the life savings you had made for yourself and any family that you may have.

Although that situation sounds dire, the good news is that it can be easily avoided with a few critically important but relatively simple legal steps – one of the most important of which is to form your business as its own legal entity.

There are few different types of entity choices you can choose from when you decide to incorporate your business – including a corporation, a limited liability company, or a limited partnership. Generally, for a solo entrepreneur, a limited liability company is the most recommended option. However, the choice of entity is always something that should be carefully considered, and we recommend seeking individualized legal counsel and an experienced tax accountant to help you make this decision.

One of the most important benefits of incorporating is that it will create a separation between your assets and those of the business. So, if the business gets sued, the person bringing the lawsuit will generally be limited in their recovery to pursuing assets of the business and not your personal assets. There are certain exceptions to this rule (known as “piercing the corporate veil” which we address in a more detailed post here.

Once you have decided to move forward with forming an entity, the next consideration is which state to register in. Typically, you will want to register in the home state where you live. If you are operating the business in other states, you may have to look at registering the business (sometimes called “qualifying the entity to do business”) in any other states where the company is performing its business. Your accountant and/or attorney can help you figure out whether your activities in a state other than your home state rise of the level of needing to register to do business in that state. You can also Google “activities requiring foreign entity registration in [STATE]” to get you started.

If you feel overwhelmed by the state registration companies, there are companies that will do this service for you for a reasonable fee. We recommend checking out Biz Filings by Wolters Kluwers as one solid option. 

Once you have decided which state to form the entity in, you will need to look up the website for the Secretary of State for that state. Typically, the website will contain instructions for how to file the necessary formation certificate to form the entity to do business in the state. One of the items you’ll need to watch out for is that you cannot form an entity with a name if it has already been taken. So, a good idea before filing any formation certificate is to check with the state to ensure the name is still available. Also consider checking to see if that name is available for use on social media (if you intend to use that name on social media) and check trademark availability with the US Patent and Trademark Office here.

The formation document will typically require some very basic information about the entity such as name, address, governing members, and the purpose of the business. All states require you to have a registered agent. Head to this link and download our free Legally Ready Guide to learn more on registered agents!

Once you’ve filed the formation document, you will receive an official notice from the state that your entity has been formed. This an important step but not the last step in your formation process.
 

In the case of a limited liability company, you will need to have a limited liability company agreement to govern the internal affairs of the LLC (sometimes also called an operating agreement or company agreement depending on the state you are in). The LLC agreement is important because it defines key decision items such as who makes decisions on behalf of the LLC, how membership interests in the LLC are held and can be transferred, how and when distributions can be made out of the LLC, and the process for liquidating the LLC when it is time to wrap it up. The LLC agreement is also important because most banks will require it to open a bank account. Note that while the formation document you file with the state is considered a publicly available document, the LLC agreement is a private document that is confidential unless it is required to be shared, such as with a bank in the process of opening a bank account. It’s important to have a well drafted LLC agreement, and we have you covered. If you are the sole owner of your business, check out our simple but also comprehensive form of LLC agreement here.

If you would like more helpful tips and information on how to get your business legally ready, click here to download our Legally Ready Guide for Health and Wellness Practitioners containing our top 15 tips to get your business ready to go!

ALTHOUGH KELLY AND KRISTIN ARE LICENSED ATTORNEYS IN THE STATE OF TEXAS, THEY ARE NOT YOUR ATTORNEYS, THEY HAVE NO ATTORNEY-CLIENT RELATIONSHIP WITH YOU, AND THEY DO NOT KNOW YOUR BUSINESS. THE INFORMATION IN THIS POST IS NOT TO BE CONSIDERED LEGAL ADVICE, AND YOU SHOULD NOT CONSIDER IT A SUBSTITUTE FOR LEGAL ADVICE. WE ALWAYS RECOMMEND CONSULTING WITH AN ATTORNEY IN YOUR LOCAL JURISDICTION SINCE THEY WILL BE ABLE TO ADVISE YOU AS TO YOUR PARTICULAR SITUATION AND ALSO PROVIDE YOU WITH INFORMATION SURROUNDING ANY NUANCES OF YOUR LOCAL LAWS THAT WE JUST SIMPLY CANNOT ADDRESS IN THIS POST. FURTHER, WE DO NOT GUARANTEE ANY SPECIFIC RESULTS.