Legal Reference & Blog

Top 10 Pitfalls for any Business Owner

October 4th, 2008 Posted in Miscellaneous

1. Forget about 50-50 ownership. You believe you and your partner will get along forever. Such utopian thoughts rarely work in business. If a shareholder deadlock occurs, your recourse is to buyout the other party or to ask that a state court appoint a receiver to dissolve the company. To avoid these problems, consider a buyout provision in your shareholder or operating agreement and the use of outside directors to provide advice and to break director deadlocks.

2. Don’t put all of your eggs in one basket. If you have separate businesses or real estate ventures, set up separate corporate or limited liability company (LLC) entities to own these assets. This way if one suffers a financial decline, neither you nor the other entities should be affected.

3. Do not commingle personal funds with business funds. Owners use a corporate or LLC entity to protect themselves from the company’s business obligations. Excluded are obligations which the business owner has personally guaranteed, payroll taxes, and sales taxes. If a business owner commingles his personal funds with company’s funds or uses the corporate account as a personal checking account, and otherwise fails to observe the corporate or LLC structure, the company’s creditors may seek to pierce the corporate or LLC veil to hold the business owner personally liable for all the company’s debts. If you are paying personal debts (car and/or mortgage) from company funds, stop immediately!

4. Don’t throw good money after bad. Business owners sometimes advance personal funds to sustain the company’s operations. Unless you are certain that the company’s financial hurdle is short-term and can be managed through better controls on expenses and/or increased sales, you may be delaying the inevitable and destroying your own personal finances if the company does not survive. It is hard to watch a company you built go down the tubes, but make sure you personally can survive.

5. Properly document your loans to the company. If you loan money to the company, sign a promissory note. Also, obtain a security interest in the company’s assets, even if subordinate to other secured creditors. Absence of a note may make your loan look like a contribution to your equity in the company, and as a shareholder, you will not receive any distribution from the liquidation of the company’s assets until all other creditors are paid in full.

6. Do not use personal credit cards to fund the company’s operations. If the company suffers a financial decline, the owner is personally responsible for paying these credit card obligations, not the company. Also, make careful use of corporate credit cards. Often the individual and the company are jointly liable on such obligations.

7. Make sure all payroll taxes are paid. Business owners sometimes use payroll tax deposits to sustain their companies’ operations during a period of poor cash flow. If the company continues to have cash flow problems, the withholding tax obligations may mushroom into a large sum. The IRS imposes a 100% penalty on the business owner and other controlling officers to hold them personally liable for such taxes. This 100% penalty includes not only the amount that is actually owed, but can include additional penalties and interest.

8. Pay sales taxes. Business owners are personally liable for all sales taxes in California. Timely pay all sales taxes.

9. Hire a competent, trustworthy controller or CFO and pay attention to the numbers. Owners often do not have an accurate understanding of their companies’ finances until it is too late. Get accurate monthly income and balance sheet statements, and review them in detail. Do not forget historical data and economic forecasts to determine the company’s current financial position. Too often, business owners focus on sales, rather than on margins, so that a company can have strong sales while drowning in a sea of red ink.

10. Face your problems immediately. There is no substitute for identifying and fixing problems quickly or, if no fix is possible, recognizing that fact soon enough to salvage what you can. Wishful thinking is deadly in business!

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