Forming a legal business entity is one of the less exciting aspects of launching a new business. However, it’s one of the most critical steps a business owner can take to ensure future success. While the process of forming a business may seem simple, it’s actually much more multifaceted than many new business owners realize. Because of that, it’s a step in the entity management lifecycle where many business owners put themselves on a path to non-compliance.
To help lift the fog over this complex process, we’ve assembled a list of five business formation mistakes that are all too common. If you make sure to check off all of these boxes, or better yet, partner with a team who can handle it all for you, your new business can focus on a more important objective: growth.
1. Not Formally Incorporating
The primary reason that business owners form a legal business entity is to protect themselves from legal action levied against the business. By formally incorporating (thus creating an entity such as a corporation, an LLC, an S-Corp, or other), you are establishing your business as separate from your personal assets. This separation means that should the business be sued, file for bankruptcy, or take other action, your personal finances and assets are protected.
Conversely, as you may have guessed, not formally incorporating means you’re leaving your personal assets and wealth vulnerable. While establishing a legal business entity may seem tedious and time-consuming, the alternative can be quite a bit worse.
2. Not Naming Your Entity
While we assume that all business owners name their business informally before they enter the marketplace, what we’re talking about here is establishing a legal name for your entity. Just because you have a name that shows up in the phone book doesn’t mean that’s your entity’s legal name in the eyes of the state.
If you do not legally establish a name when forming your entity, you will instead be assigned a number by the state. Rather than your informal name, that identification number will be used in all legal proceedings. This creates confusion related to brand recognition in your home state, but can cause even greater issues as you look to expand. If you enter a new state, but that state has already assigned the number you use in your home state to another entity, you’ll instead receive a new identification number to conduct business within that state. As you can imagine, the more territories you enter, the more confusing this can get. The wiser course of action will always be establishing a legal name from day one.
3. Naming Your Attorney As Your Registered Agent
As we’ve covered in other articles, businesses must have a registered agent in every state in which they do business. These RAs provide your business with a legal address for secretary of state correspondence and handle all service of process tasks, among many smaller tasks. Many business owners make the mistake of choosing their corporate attorney as their registered agent, but there are many reasons why that is not a wise choice.
There are multiple types of legal insurance that will not cover the attorney if they’re acting as the registered agent for their own legal client. On the client’s side, your business will be put at a larger risk of default judgments, and state penalties could be assessed against your business for non-compliance with jurisdictional filing requirements. With the growing number of completely digital registered agent solutions on the market today (like Legalinc, which serves all 50 states), choosing a provider other than your attorney is simply the right choice.
4. Not Formalizing Business Partner Agreements
This particular topic involves some minor discomfort at the outset of your business but can help avoid controversy and complications down the line. When going into business with a partner or partners, things typically start off smoothly and with much excitement. This often results in partners choosing to avoid broaching the topic of a formal partnership agreement, which would lay out many different aspects of how their business will function day-to-day.
From important aspects of business, like how profits will be divided, to how new partners are added, or how current partners are bought out, these are functions that must be formalized. By not having these tough conversations and putting pen to paper, you’re leaving your business open to bureaucratic gridlock amongst your partnership group.
5. Handling Your Own Annual Reports
Annual reports filing is among the most important and most overlooked aspects of operating your legal business entity. Every single state in which you do business requires you to file annual reports, but each of those states has a different due date, different fees, different filing guidelines, and different penalties.
The process of maintaining clean records and filing appropriately is tough enough if you’re only operating in one state, and it quickly becomes overwhelming if you’re operating in many states.
In fact, it’s not uncommon to see a business not realize that they’ve missed a date or filed incorrectly, thus resulting in state penalties and legal action they’re also not aware of. In some cases, you will see business owners not even realize that their legal entity has been completely dissolved in the eyes of the state due to missed and incorrect filings. Instead of handling this process yourself, we encourage anyone operating a business to partner with a firm like Legalinc to automate the annual reporting process. In fact, Legalinc now offers automated annual reports filing & due date monitoring as a subscription service in all 50 states and Washington, D.C.
If there is one consistent element within all five of the common mistakes mentioned above, it’s choosing to handle your business formation the right way rather than the easy or the quick way. By formally incorporating, choosing a legal name, finding an appropriate registered agent, establishing clear partnership guidelines, and choosing a trusted partner for annual reports filing & monitoring, you’ve effectively ensured your entity’s indefinite compliance. The only missing piece is choosing a company like Legalinc to provide ongoing compliance monitoring to make sure you never fall out of favor with any state in which you do business.
If you have any questions about the mistakes mentioned above or want to learn more about what Legalinc can do to make sure you don’t have to worry about making them in the first place, reach out to our Customer Success Team today!