If you run practically any business these days, you should form either a corporation, limited liability company or other entity to protect yourself from liability. While this is true, most businesses do not realize there is a gap in the protection.

For the purposes of this article, I am going to group the traditional corporation and more recent limited liability company creation together as a corporation. They are actually very different entities, but both have the common characteristic of providing liability protections for the owners of the business, be they members or shareholders.

A corporate entity provides protection from personal liability for the debts of business. Unless the corporate entity is a fraud, the “owners” personal liability extends only to the amount they have invested in the business. Company debts or lawsuit judgments do not pass through to these owners. This concept is written in stone, but there is a problem.

Let’s assume you start a business to create and sell the proverbial magical widget. This widget solves a common problem and you have plenty of seed money to get the business up and running. You form a corporation, sell shares to a set number of people and off you go. You file for a patent on the widget, a trademark on the logo, and buy the manufacturing machinery. The business starts making sales and is profitable within a year. The future looks great and the business buys a large tract of land for expansion.

After a couple of years, the business decides to expand its product line. The new product sells like mad, but lawsuits start rolling in. It turns out there is a design flaw and people are being injured by the new product. The lawsuits start stacking up.

How are you positioned at this point? Well, you have protection from personal liability for the lawsuit judgments. This is of little comfort, however, given the fact that most of valuable assets of the business are exposed. Think about it. The real estate you own, the intellectual property [trademark, patent], manufacturing equipment and original product line are all corporate assets. Any judgments against the business can be collected against those assets. In short, there is a gap in the corporate protection.

So, how do you close this gap? A proper corporate strategy would involve the partitioning of risk. In the scenario above, there are some obvious steps that could be taken. The real estate purchased by the corporate entity, for instance, should have been purchased through a new business entity. The manufacturing equipment should have also and then been leased back to the main at risk entity. The intellectual property, again, should have been parceled out into another entity and so on.

As your business develops valuable assets, it is vital that you implement strategies to limit the impact of negative business developments. If you fail to do so, you will develop a gap in your protection without realizing it. Once that gap is exploited in a lawsuit, it will be to late to fix the gap.

Richard A. Chapo provides California incorporation services through SanDiegoBusinessLawFirm.com.

Tags: assets, corporation, incorporate, incorporation, law, lawsui, legal, llc, personal liability, shield

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