Key Considerations when Selecting a Legal Entity

Key Considerations when Selecting a Legal Entity

As an entrepreneur it’s extremely important to “know what you don’t know” when selecting the appropriate legal entity for your business. As an attorney and small business advisor, I am shocked by the amount of conflicting and somewhat confusing information now available to first time entrepreneurs. Consequently, I am not surprised by the number of people that have put the “cart before the horse” by beginning their business without knowing the facts.

When selecting a legal entity for your business, it’s critical to look at the following “Key Considerations” as they pertain to your specific individual needs and the short- and long-term impact on your business.

Management and Control

The first Consideration is determining the appropriate management structure. How and by whom will the business be managed, and what rules, policies and protocols will be implemented for the success of the business? This is as much a business as legal consideration and consists of the following analysis.

First, do you, the entrepreneur possess all of the knowledge, skill, client contacts and insight to operate the business by yourself, or do you need assistance from others who will provide different but complimentary resources (e.g. knowledge, property or cash)? Once this is determined, the business will need to establish a set of rules and protocols for managing the business operations. Issues associated with how daily decisions and disagreements are handled, what products and services the business will offer and what happens if the principle becomes unavailable, deceased, permanently disabled, or divorced. Life’s unexpected circumstances must be accounted for. Each legal entity has its own management structure and rules for governance set forth under state and federal law, it’s not a “one size fits all.” The trick is to identify the entity that provides the type of structure that resembles your business model and to have your operational documents “customized” to reflect the specific needs of the principles. This process is not rocket science but does require the input of a business professional that understands the effects of the desired structure and can help facilitate the process.

Liability Protection

The “foreseeable liability” that may be incurred by your business and yourself as a principle if the second Consideration is. Although liability is a concern for all businesses, not all businesses have the same foreseeable risks nor do they carry the same likelihood of being sued. The question is: given the nature of your business what are the foreseeable risks of liability and what can your business do to minimize the potential consequences. Generally, all legal entities, including LLCs and corporations, can be held unlimitedly liable for damages directly resulting from the acts and or omissions of its employees, officers or members. Therefore, if there are foreseeable risks of liability your business should at least explore the possibility of carrying some form of commercial liability insurance to insure against the loss of assets in the event of a lawsuit. Generally, coverage will protect against those listed “foreseeable risks” and will provide limits to the coverage sufficient to cover the business’ assets. Premiums should be based on the dollar value of the assets being protected and the likelihood of the risk.

Personal liability incurred by the individual principles, shareholders, officers or members is generally limited to their own personal contributions (money and or property) made to their business (the total capital contribution or investment) and therefore does not extend to their personal assets (residence, investment properties, personal property, etc…). The exception is if the individual principle is found to have been “grossly negligent,” intentionally violated the law, or committed some other form of intentional wrong-doing that causes others harm. These situations will cause the individual wrong-doer to be held unlimitedly liable for all damages, without the benefit of insurance coverage.

Every entrepreneur should review all potential foreseeable liability and determine whether they need commercial liability insurance to protect the value of their business assets, and to always use “reasonable care” when providing their products and services or working with other third parties.