Momentum Podcast: 299
Build Only On A Solid Foundation
by Alex Charfen
If you're running a business, listen up, building a company on an unstable foundation will leave you exposed and unprotected. The new world of DIY legal services online is exposing entrepreneurs to a host of liabilities.
A lot of people don't take care of the legal issues and challenges associated with starting a corporation for fear of the expense, some attorneys out there are taking advantage of the rush of entrepreneurs wanting to start a corporation and are overcharging for their services, avoid them.
Find a good attorney, good legal advice is worth your money and it may not cost as much as you might think. I want to make sure you're building only on a solid foundation and will be protected moving forward.
Full Audio Transcript
Build only on a solid foundation. These days, it's easier than ever for entrepreneurs to start a business. But is that a good thing? This podcast is going to cover why so many entrepreneurs are exposing their businesses, themselves, and even their families to personal liability that is totally unnecessary.
All of that could be corrected by just creating a solid foundation first. Now here's the challenge with business today. Starting a corporation, having an LLC, a sub-chapter S, and a C-corp is easier than it's ever been in history. I remember when I was younger, when we started corporations we used to have to hire registered agents who physically went into a government office, filed articles of incorporation. It took weeks, sometimes months to get it done. And then you would finally have your EIN number, your employer identification number which is kind of like a social security number, but for businesses. And you could operate as a corporation.
Now today, 99% of the friction from that process has been removed. You can go onto one of a number of different legal websites. If you put in Google, "Start a corporation." Within about 45 minutes you can have everything done. You can have everything filed for the corporation, and as soon as it all gets to the state that you incorporated in, you'll get that EIN number. And it happens in minutes, what used to take weeks or months.
Now here's the challenge. That ease of use, that lowered barrier to entry has a lot of entrepreneurs making decisions in their business that don't create a solid foundation. In fact, it feels so easy and seems so easy to get started today, we can cause massive issues in our companies when we don't really understand what's going on.
I want to share with you, three stories of issues that I've seen just in the past 90 days with entrepreneurs who have started a company, did not fortify the foundation, and are now going back and scrambling to try and fix it. First, let's start with a simple one.
We have some clients, there's three of them. And they have a corporation in the health space, and they're trying to clear up some disagreements that they have with how they're going to run and operate their company. Now, what you should do when you have challenges with running and operating your company in a business where there's three partners, is you just simply go to the operating agreement that you wrote when you incorporated, and you look at the operating agreement. It should spell out how you resolve issues. It should also spell out things like what do you do if one partner wants to leave the business? What is the reciprocal buy/sell agreement? Like if you want to leave, here's the process through which we get you out, but here's how we determine the value. What's the process if something happens to one of the partners in the business?
If you don't have these spelled out in an operating agreement, you default to whatever state law is. A lot of times it can be massively detrimental to the organization. But in this case, here's the problem, this three person partnership incorporated using an inexpensive legal site, and they didn't create a true operating agreement. In fact, they used some template from the legal site, just to kind of check a box that they had it. But they didn't actually do the thinking of, "What are we going to do when there is a conflict? How do we make decisions together? What do we do when one of us wants to do something and the other two don't? What do we do when one of us wants to leave the partnership?"
See, when you answer those questions up front, it's a totally different scenario, than what they're in today. Because they started the company about a year ago. It's now headed towards a multi-million dollar business. It's become a lot more important to all three of them. Now, they're trying to have the operating agreement conversation after the fact, 10 months in. When there's money that's been put into the company, when different people are working different numbers of hours, when what they've done is they've done what they've needed to do to make the company survive and thrive. But now, there's massive questions as to how they're going to move forward.
It's incredibly difficult to make these decisions in retrospect. It's incredibly difficult to go back to the mindset with which you started the company, once it's up and running and it's a multi-million dollar business. And as a result, they're having to do this in reverse. That is painful. I don't ever want to see you go through this. If you hire a good attorney ... one of the reasons ... let me start that over. One of the reasons that a lot of people don't do things the right way, one of the reasons that a lot of people don't take care of the legal issues and the challenges of starting a corporation is fear of expense.
The fact is, if you hire a good attorney to write some articles of incorporation for you, and an operating agreement, it can usually be in the $1,000 to $2,000 range, maybe less. Now some attorneys out there are insane. They're taking advantage of the rush for entrepreneurs to build corporations. They're taking advantage of how many people out there are actually starting corporations, and for simple operating agreements they're charging $5,000 to $10,000. Avoid them. Find a good attorney. We use an attorney out of New York that charges somewhere between $1,000 and $2,000. This isn't something that you should be doing on your own. Get some legal help so you know you set stuff up correctly.
Let me share with you a second story. Now this one, is incredibly painful. See, one of the reasons we start corporations is that a corporation acts as a shield. It acts as a buffer of liability between you and the world. When you start a corporation, that corporation operates as a separate entity, and it has all of the liability for your business. So if somebody sues your corporation, or if your corporation does something and somebody sues your corporation, then they're going after that company, not you.
So it doesn't matter how much money you have, how big your house is, how much wealth you have. If somebody sues your corporation and wins, and there's no money in the corporation, most of the time, the vast majority of the time, they can't come after you personally. But we have a case where we have a client that started a company about five years ago. And over the course of the last five years, that company has done increasingly well. In the last few years, they've started to really treat it like a business, and do the things you're supposed to do for a business, and make sure that they have separate business banking accounts, and they're separating the funds, and they're doing all of those things in the past couple years.
Now, here's the problem, they've recently been served with a lawsuit by an attorney for an ex-employee that has intimate knowledge of the company. One of the things that that employee knows about the company is that for the first few years, and even a few times in recent years, the owner has treated the business bank account as a personal bank account. So when they didn't have money in their personal bank account, they paid their rent bill a few times out of the business. When the business was started, they paid most of their personal expenses out of the business. They were paying for a nanny, and for clothes, and for groceries, and for their apartment, and then eventually their home. And over time, they paid less and less out of the company, however, they treated the business like a personal bank account.
So what the attorney who is suing that company is now attempting to do is what's called piercing the corporate veil. See what this company is doing is leaving very little cash in the business. They're taking it out and putting it to their net worth. That's what I suggest every owner does on a monthly basis. Your business should not be cash rich. Your business is a liability, and when it has too much money then it's easy to sue and get money from. So instead, take distributions on a monthly basis, leave a minimal amount of cash in your business. Then if somebody sues the company, there's not much for them to take.
Now, here's the problem. You start treating your business like a personal bank account, you start writing your personal expenses out of your business bank account, and an attorney who knows what they're doing or has knowledge that that's happened, can go through a process called piercing the corporate veil. They can go into court and say, "This person has a corporation, but they're treating it like a personal bank account. And because they're treating it like a personal bank account, they should be personally liable for anything that the corporation does." And while it's incredibly rare for this to actually happen, the place where you can absolutely get in trouble is when you're paying personal expenses out of the corporate bank account.
So now, this person is incredibly exposed, because they really have been treating the business bank account like a personal bank account. If you're doing this right now, if you're writing personal expenses out of your business bank account, go cut your business a check out of your personal account, for every expense you've had. And if you accidentally ... Cadey and I sometimes pull out the wrong debit card. I'll go to Whole Foods and I'll accidentally put it through as a business expense, and I'll go home, file an expense report that shows that I accidentally did that, and we write a check to the company, because we don't want any liability with piercing the corporate veil.
So just because you incorporate doesn't mean that you're doing the right things. In fact, if you incorporate and you don't treat the company like a business, you don't separate it from you personally, you actually have no protection because somebody can come along and say this corporation is not real. I don't want you to find yourself in that situation. That will rock your foundation to the core. It means everything you've ever done as a business, you're personally liable for, and it's not that hard to prove, once you start paying personal expenses, you don't have a lot of excuses and you don't have a really great defense. I don't want to see that happen to you.
Now, the third situation that I've seen, and again, this is recent. I recently talked to some friends of ours, that have an international company here in the United States. They live over seas, but they've operated a business here in the United States for the last several years. Well, in operating that business, they had a US partner, so there was a foreign partner and a US partner. Well they filed the tax return for the business, and they accidentally filed it as though the person filing it was a US citizen, even though they lived internationally.
Now this is a major mistake, because if you're not a US citizen, you certainly can't file your taxes as a US citizen. There's different rules for those who are US citizens, and those who aren't. There's actually different filing paper work. You file as a foreign entity that owns a US corporation. And here's how they found out that they had an issue, because they made this mistake in filing, the last time that they tried to get into the country, they were pulled out of the customs line, taken to a detention cell, held for over two hours, and asked a long list of questions.
Let me tell you something. Until you've been in a holding cell, you don't realize how terrifying it is to be sitting in a room you can't get out of. Two hours feels like two days. When I was younger and I ran an international consultancy, I used to travel to Latin America, and I would do trips like Mexico to Columbia, to Venezuela, to Argentina, to Brazil, and then I would come home. And often, because I was bouncing around to countries where there was challenges with the United States, Venezuela always had issues going back and forth with the United States. Columbia was seen as a place exclusively where drugs came from, even though we did a lot of business there, and it was a great territory for us.
So I would occasionally, coming home, get pulled out of line and questioned. I wouldn't get put in a detention cell, I got put in the group holding area. I wouldn't get locked up, I would just get held. Just getting held for 45 minutes or an hour would make me restless and uncomfortable and I'd be freaking out. I can't imagine being put in a six by six cell with a folding table and sitting there for a couple of hours wondering if the US government is going to release you.
And let's remember. After 9/11, all bets are off. They can hold you until they don't want to hold you anymore. If they think you pose a threat, they can hold you indefinitely. And of course, there's rules and regulations around it, but man, it's a lot easier for the government to hold you than it used to be. And these friends of ours are now having to go back and redo everything they did. And so, check this out, even though they filed a tax return, where the IRS got money, so even though they gave that money to the IRS, they didn't file the tax return correctly, so they're going to have to go back and refile a correct tax return, and the IRS kind of loves it when you do that. Because they can go back and now say, since you're filing this today, here's how late this return is, here's how many penalties you have because of being late. Here's the fees you've accrued, the interest you've accrued. So whatever your tax liability was, it's now gone up a significant percentage because you made mistakes in how you filed the taxes.
See, building a company on an unstable foundation will get you exposed. It will challenge you and challenge your stability, and it might even put you in a holding cell. These things are serious. So here's what you should be doing. If you're a corporation right now, make sure you have everything in the right place. You're treating the company like a company. You have separate bank accounts, you're not mixing the business and personal expenses. If there is ever a personal expense that accidentally sneaks through, do the paperwork internally to correct it immediately. Talk to an attorney, make sure that you have your corporation set up correctly, that you have a valid operating agreement, that you have what you need to be a real company. And if you're operating internationally, talk to an international business attorney that can help you understand what you should be doing and file your taxes through an accountant that understands international business.
See, this new world of do it yourself business, or DIY business is exposing entrepreneurs to an entirely new world of liability. If you are going to write your own articles of incorporation, if you're going to do the paperwork yourself, make sure you know what you're doing. Cadey and I have owned hundreds of companies, we could go file the paperwork ourselves, we know exactly how to do it. We have an attorney do it anyway. The reason most people avoid getting legal advice is they're afraid of the expense. There's this mythology in the minds of entrepreneurs that every time you call an attorney it's going to cost you thousands of dollars, or tens of thousands of dollars or be prohibitively expensive.
That thought process, that belief system is reinforced by the companies who market do it yourself legal services online. Here's the reality, for $1,000 to $2,000 you can get a good attorney to write your operating agreement, file the articles of incorporation for you, and make sure you're protected. Then keep that attorney to give you advice, and ask them, what do I do to make this valid? What should I avoid to make sure that we don't get into problems? And have them help you write the agreements you need, so that you have a solid foundation for your business.
Today, entrepreneurs are growing multi-million dollar companies faster than they ever have, in the history of business. Entrepreneurs are getting opportunities like we've never had before. The tools, the resources, the platforms available to us can help us grow faster and in a more profitable way, than I've ever seen. All of this is incredible for us as entrepreneurs, but it also exposes us to massive liability if we don't take the time and get the right advice to put the foundation in place first. Build only on a solid foundation, and that way, as your company grows, your net worth grows, the value of the organization grows, you will be protected moving forward.
If your business is growing and you want to turn it into an empire, if you're ready to build a team around your company so that you can grow fast, if you're ready to actually see your business move forward with a team that fully supports you, and feel confident, then connect with us. I want to make sure that we connect, and you come to one of our events. If you go to billionairecode.com/summit you will see the next event that we have coming up on September 13th and 14th. This event is about three things. One, helping you build a strategic plan with your business that you and your team can execute. Two, helping you build the communication system cadence that you have within the business, so all of your team knows where you're going at any given time. And three, let us show you how to build the infrastructure of your business around the opportunity you have, and you will go forward quickly.
Go to billionairecode.com/summit, answer a few questions, see if you're qualified to attend our event. Spend two days with some of the most successful entrepreneurs out there, growing multi-million dollar businesses. It's an incredible room to be in, and if you want to see your business in an entirely different light, give me two days and I will give you insights on your business that will give you confidence you didn't think was possible. Billionairecode.com/summit.