Axioms for Business Activity

There are certain propositions that should be considered as axioms for an individual conducting business activity:

  • No business activity should be conducted outside the limited liability shield.

Limited liability means that the owner's capital investment in the business is at risk, not the owner's personal wealth. Absent an owner's fraudulent conduct, liability for a business action will not be paid from the personal assets of the owner. No business activity should take place without limited liability protection. A common mistake occurs with the casual partnership. Under most state laws a partnership may be formed with an agreement to share profits and losses in an enterprise. This agreement need not be in writing. A partnership does not have limited liability protection. Therefore a simple oral agreement to share profits and losses concerning an enterprise may form a business entity without limited liability protection.

  • Each discrete business activity should have its own limited liability entity with risk protection (including insurance) as appropriate for that entity and its activities. The entity type should have, in addition to limited liability, the tax result appropriate to the operation of the entity.

Courts will not enforce limited liability protection unless the capitalization of an entity does not defraud its creditors. This means that each owner must place an appropriate amount of capital in the entity and the entity must maintain a reasonable amount of insurance protection for the activity it conducts. Past this requirement, there is no legal requirement to keep sums of money in the entity. Absent a business purpose to accrue cash in the entity, which favors the C corporation as an entity type, most owner-managers will be working to place money in the entity so they can pay themselves. This cash flow arrangement favors the S corporation or the limited liability company. Generally, the advantage the S corporation has in this situation is the ability to pay employment and trust fund taxes from a set salary and tax free or pass through treatment of dividend amounts to owners. Owners are not employees of limited liability companies, which are taxes as partnerships, and all amounts paid to owners are subject to employment and trust fund taxes.

  • Each discrete business activity should have ownership agreements assuring  minority and majority owners of value for an interest in the business.

Owners can protect the value of their business interest, whether majority or minority, by entering into an agreement with the other owners regarding what will be paid should an owner sell his or her business interest. If there is only one owner or there is not such an owners' agreement, there is no assurance as to the failure an owner may realize from that owner's business interest.

  • The marketability of any business is enhanced if it operates on its own measure - clearly separate from any other business, linked as may be appropriate by written business agreements to those with whom it does business.

Any business which depends on another business for its success will not be valued as highly as a business which can stand alone. If there is a dependent relationship, then the dependency should be cured to the extent possible with a written agreement establishing the rights of the dependent entity.