A common question I get regarding setting up an entity: “When should I set up my LLC/Corp?”
As an attorney who is a stickler for doing everything right, right away – my immediate answer is: “Before you start signing anything, spending money, and collecting money.” Here’s why:
Amelia Entrepreneur is starting a consulting business. Go Amelia! Get that bread! (That’s what the kids say these days, right?)
Here’s a few of the things that might happen between when she decides to start her business and she launches:
• She hires a web designer to create her website
• She signs up with a credit card processing service
• She hires a bookkeeper (smart!)
• She opens a business bank account (critical!)
• She rents an office
• She gets insurance in place (good call!)
• She finds a free sample of a client service agreement online and puts in on her letterhead (oh boy)
Seems like Amelia is on the ball here! She did get a lot in place, but didn’t set up her LLC or Corp yet because “I am not earning $XX amount yet.”
Well, she’s entered into at least 4 agreements with different service providers (CC processor, bookkeeper, landlord, web designer) and is now individually on the hook for all of them. When she enters into her client service agreement with her clients (and we can talk about how she made a mistake there later) – she is personally responsible for any liability that might arise from them.
Setting up an entity AFTER all of this happens means, in the best-case scenario, Amelia has a bunch of work to do (or pay her attorney to do) to transfer these agreements to the LLC/Corp (this assumes the other party to the agreement will consent to this but none of the parties to the agreements have to agree to such a transfer and very well may not, having Amelia on the hook can be more attractive than having a new LLC on the hook). The worst-case scenario is that everything pre-LLC remains outside the scope of the LLC and Amelia remains personally liable.
Amelia doesn’t have to earn a single cent for an issue to arise for which she might be stuck paying for an obligation or judgment– maybe she breaches her agreement with her bookkeeper, and gets sued for liquidated damages; maybe someone is injured after tripping on the slippery area rug in her office before they even hire her; maybe she gets served a TM infringement complaint because she unintentionally picked a name for her business that infringes someone’s trademark.
Liability doesn’t start with earning money. It begins when you start taking actions within, or to create, your business. And without an entity, all that potential liability rests on Amelia – putting her personal assets at risk.
So, what’s the best course of action?
Set up the LLC before you start getting into agreements, not after. And if an agreement absolutely must be entered into before the LLC/Corp is set up, include a clause which allows for the assignment of the agreement from you individually to your new entity.
Already up and running and realize you need an LLC now? It’s not too late, and still worthwhile – do not take this cautionary example as “do it now or lose the chance forever.” Late is always better than never. But the longer you go without an entity, the more the potential liability piles up. When it is too late to protect your assets is after a claim or lawsuit or judgement happens. So don’t wait until that happens. Prevention and preperation is always easier and less expensive than reaction.