The starting point for every business is creating a legal entity, but what does that mean? You know it provides tax benefits and limits your liability. But to understand why you need to know what an entity is.
The law treats an entity in the same manner that it treats a real person. This legal concept is vital in understanding the relationship between business owners and that entity. Let's explore this concept.
Business owners are likely savvy enough to know that you need to run the business out of a legal entity (for this article, we will use the typical type of the limited liability company “LLC” example, but there are many different types).
You know an LLC limits the liability of the company in addition to providing tax benefits. But these advantages only scratch the surface of the potential advantages an LLC can bring to your business.
Remember, in the eyes of the law, an entity is a person. Thus, legal entities are people. In reality, an entity is nothing more than a piece of paper filed with the secretary of state. But once it is submitted, it is now a person. In legal terms, this concept is called a legal fiction. Meaning the law knows it is not a person but pretends it is anyhow - a "pretend friend".
The result: an entity can own property and assets. It can be named in a lawsuit or file a lawsuit. An attorney can represent it. It generates its own income and tax liability. An entity can own other entities. It can even be criminally prosecuted. And so, on and so forth. The key here is that an entity can do anything a person can do with a significant difference. Since entities do not exist, they can only do things through their agents.
No, I am not referring to FBI agents (although it is the same principle); an entity's agent is its owners, managers, and employees. Consider Tom Brady's sports agent. Mr. Brady hires her to negotiate with NFL teams after Mr. Brady instructed her what contract he desires. Once found, his agent can enter a contract, on his authority and on his behalf. This agent relationship exists in the exact same manner that business entities operate. Entrepreneurs, business owners, and managers should understand this concept, and by doing so, a business owner can better identify future issues that might need legal assistance to resolve those issues.
By understanding this concept, you now know why the entity creates limited liability because it is a person. You couldn't be found liable for something your neighbor has done; similarly, in many situations, a business owner cannot be found liable for something their business does. Instead, the business's assets will compensate another business or person the business is liable to, not the business owner's personal assets. In other words, “I didn't steal the cookies from the jar, my pretend friend did.” Use you pretend friend to point the finger at.
Note: Keep in mind an important point. An entity, in most circumstances, does not protect a business owner's personal assets from personal liability the owner creates. Example: imagine a spine surgeon commits malpractice by leaving a sponge inside his patient's back (it happens). Assume the spine surgeon runs his business in an LLC. In this situation, both the LLC and the surgeon could be held liable. Why? Because both are people, thus both acted negligently. But, now imagine the surgeon is in business with four other surgeons operating under the same LLC. The other four surgeons will most likely not be personally liable for their partner's mistake, just the LLC. Without an entity, all five of them could be personally responsible.
The point? Understanding that an entity is a person in the eyes of the law helps a business owner understand potential issues that may arise in the future and why the concept cerates limited liability. By doing so, a business owner can resolve these issues before they arise.
Please note: the contents found on this website are not legal advice and is strictly intended for educational purposes only. The legal needs of each individual vary significantly and are dependent on a variety of factors relevant to their specific needs. Please Contact Us if you have any questions about this topic or would like to Schedule a Free Consultation.