Discussing your choices for the form of your company with an attorney is strongly recommended. The most common company forms are:
Sole Proprietor. This legal structure is very common. It is very easy to setup, and there are fewer requirements to file applications with the government compared to other forms of companies. You should check with your local town or city government, and county, for business license requirements, and zoning requirements as well. As a sole proprietor you own the business. Indeed, you are the business whether you have employees or not. Except for what you delegate to employees, you have full control and total authority for the business. Of course, you are then totally responsible for anything that happens to the business, and you cannot avert liability. The profit and loss from your business is typically passed along to your personal tax returns, (see IRS Schedule C for federal taxation). The business does not file its own “return” but the net profit or loss is shown on your personal tax return. If you have no employees, you probably do not need a federal tax identification number for the business. Instead, your social security number associated with your personal tax return serves as an identification number associated with your business venture. Before you hire employees, be sure to file for an Employer Identification Number (EIN). If you reside in a community property state, your spouse is likely to be deemed as having a half interest in the business. Consult with your attorney for the local, state and federal regulations that apply to your sole proprietor business. Make sure you understand that the primary disadvantage of a sole proprietorship is the owner’s unlimited liability in the event of damages, lawsuit, or other financial losses. You do face the risk of a pet being hurt, and in some businesses, pets have died of natural causes at the pet groomer. Ask your attorney to make it clear what you face losing as a sole proprietorship.
Partnership. Two or more owners form a partnership. It is essentially a sole proprietorship with two or more owners. Partners share authority, control, responsibility, liability and profits or losses. The basis of their sharing is either equal or not equal. Each is liable for the actions of the other within the business. It is very important for a partnership to be made by a formal agreement with the assistance of an attorney defining the contributions, authority, liability, control and remuneration for each partner. Typically profits and losses from the business are passed along to each partner for their personal returns, again, you should seek legal and accounting assistance in this matter. Partnerships must apply for federal identification numbers and file business returns in order to report the profit and loss of each partner. Why have a partnership? You have more resources than just you. A partner contributes knowledge, skills, good judgment and timely assistance. However, not all partnerships work out well. They require joint trust, commitment and concern for the business and the other partners. Is this possible for you? Are you comfortable with possibly being held liable for your partner’s activities? In fact, it is sometimes possible to be held liable for a partner’s activities outside the business partnership.
Corporation. The corporation is its own being, a living being separate from its owners. A corporation requires a charter from its resident state when formed. Owners are the “stockholders.” In return for your financial investment of capital into the corporation, you are given stock. In return, you can also be given dividends and a portion of the profits from the corporation. You can also be paid wages issued by the corporation, as an “employee.” Stockholders elect a board of directors to guide the corporation and protect its interests. Officers are elected by the directors to run the day-to-day business. Officers and directors are responsible to the stockholders. In many states, a corporation can be formed and operated by one person like you. We strongly recommend legal counsel when forming a corporation. The corporation can dramatically reduce your liability for the business, including debts, but there are important exceptions. Stockholder “owners” are liable generally to the extent of the investment of stock, should the corporation fail. Officers and directors are responsible for their actions, and can be fired and re-elected, but generally, their liability doesn’t to their personal assets (but again, there are exceptions). To incorporate not only requires counsel, but special filings and additional paperwork on an ongoing basis. The cost of incorporation varies by state, and the mid-range cost is several hundred dollars. Don’t overlook the ongoing functions of a corporation to hold a minimum of an annual stockholders’ meeting, elect directors and officers, maintain a “corporate minutes” book with the involvement of the directors and stockholders as appropriate. Be sure you understand the taxation procedures for a corporation. The corporation pays corporate income taxes on its profits, and then distributes dividends to its stockholders, and the stockholders are liable for personal taxes on dividends they receive. Remember, the corporation pays wages to its employees, and you as a manager and groomer will likely earn wages and be paid in the form of paycheck with payroll taxes deducted. At the end of the year, the corporation will provide you with a W-2 statement of earnings for those wages, along with other forms of remuneration the corporation may have paid you. Again, be sure you clearly understand the workings and requirements of a corporation with tax counsel including an attorney and Certified Public Accountant. In fact, we have worked with CPA’s who were also attorneys, very convenient! Are all corporations the same? No. Your counsel can explain the differences between a “S” and “C” corporation.
LLC – Alternative to Incorporation. Setting up a corporation or LLC involves important legal issues you must address. The implications are significant, including tax and accounting. Therefore it is vital that you discuss these issues thoroughly with your lawyer and certified public accountant. We will look at general legal issues here that are applicable to corporations and LLC’s throughout the U.S., and some specific to California. Keep in mind that the actual formation of your entity is essentially governed by state law, and that means your legal and accounting advice should come from professionals in the state in which you plan to operate your organization.
A common motive for organizing an incorporation or LLC is to address liability for caring for other people’s pets. There are grooming business owners that have faced lawsuits from their clients based on pet owner allegations that the grooming services caused or enhanced harm to their pets. Of course there are groomers that have even pleaded guilty to physically abusing pets. Sometimes these are employees and other times the owner, so owners face liabilities created by employees as well.
Let’s make one fact very clear; merely establishing a corporation or LLC does not provide perfect insulation from personal liability from third party creditors. Let’s take a closer look.
Under some circumstances, Individual members of LLC’s or shareholders of corporations can shield themselves from personal liability to third parties and limit it to their membership or shareholder investment. There are limits to effectiveness of this shielding, and yet it may be more effective than simply being a sole proprietorship. The protection of a corporation can be affected by lawsuits attempting to “pierce the corporate veil” and similar attacks can be made on LLC’s. Imagine the owner of grooming business who knowingly abused a pet that died (uncommon, but it does happen). Under these extreme circumstances the law may uphold making the members or shareholders personally liable for what might otherwise be debts and obligations of the LLC or corporation. Certainly the sole proprietor involved in such a situation would unquestionably have no protection at all in such a lawsuit.
The basis of allegations involved in such lawsuit to pierce liability protection is “alter ego.” California Corporations Code, section 17101 provides in part:
(a) Except as otherwise provided in Section 17254 or in subdivision (e), no member of a limited liability company shall be personally liable under any judgment of a court, or in any other manner, for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, solely by reason of being a member of the limited liability company…
(b) A member of a limited liability company shall be subject to liability under the common law governing alter ego liability, and shall also be personally liable under a judgment of a court or for any debt, obligation, or liability of the limited liability company, whether that liability or obligation arises in contract, tort, or otherwise, under the same or similar circumstances and to the same extent as a shareholder of a corporation may be personally liable…except that the failure to hold meetings of members or managers or the failure to observe formalities pertaining to the calling or conduct of meetings shall not be considered a factor tending to establish that a member or the members have alter ego or personal liability for any debt, obligation, or liability of the limited liability company where the articles of organization or operating agreement do not expressly require the holding of meetings of members or managers.
On the surface, these two cites seem in opposition. However, they are not. Section (a) provides a shield against the mere allegation or proof that a person was a member and nothing more. The same would be true of a shareholder in a corporation. The missing link to understanding the depletion of the “shielding” is Section (b). It clearly states that a member of a LLC can be liable to the same extent as a shareholder of a corporation under the law of “alter ego.”
To avoid this, the LLC or corporation must be treated as a completely separate entity from its members or shareholders. It cannot be treated as merely an extension of the member or shareholder. This means that he member or shareholder cannot withdraw monies from the LLC or corporation at will. Bank accounts must set up in proper order too making clear the separation, very clear.
There are more cracks which creditor lawsuits will attempt to find and use to pierce the veil. There are formalities that must be followed whether an entity is a corporation or LLC. In the corporate world, regular and annual meetings are expected, and notices of such meetings must be properly distributed, signed and filed, or waiver notices of these meetings properly handled. When they are not, the corporation has a crack that may be attacked. As noted in section (b) above, one of the exceptions to the liability issue in LLC’s is that the failure to observe formalities cannot be used by such creditors as proof of the alter ego liability provided that the articles of organization or the operating agreement do not expressly require the holding of such meetings. Thus, when your form your entity and prepare these documents, you must be absolutely certain that the “forms” you are using do not state that such meetings are required. Ask your counsel about this requirement in documents they prepare when assisting you to form your entity.
In California, a member of a LLC can also be liable if the member has expressly agreed to be liable under a written guarantee. Behavior of a member or shareholder can be classified as “tortious conduct” and again open the path to liability. Again, severe mishandling of pets where neglect, harm or malicious handling is involved is certainly open to rulings of “tortious conduct.”
Here we have looked at the most common misunderstandings, especially that just having a LLC or corporation is perfect protection. You need legal and financial guidance when forming a LLC or corporation, and don’t treat it just as a set of papers you sign. Not all organization papers are the same. Read all documents, and ask questions. It is the liability of the professional taking money to provide you with services to answer your questions, so do so. Be warned that we never suggest using do-it-yourself organization kits and software for matters of company formation. ♦