While maintaining adequate capitalization to continue company business activities is simply sound, basic business strategy, there is another reason to keep your corporation or LLC adequately capitalized: Protecting yourself from creditors.
Some business owners think that maintaining a “corporate veil” protects business finances from private finances and in lawsuits against the business, creditors can’t touch private finances. That’s not entirely true.
Some courts have ruled that creditors can hold shareholders personally liable if the corporation was not adequately capitalized.
The ‘corporate veil’
A corporation or LLC is a separate legal entity. It has accounts, property and equipment that is separate from any of its owners who have their own accounts, property and equipment. Although the owners work with and benefit from the corporation or LLC, they are separate from it. That’s called the “corporate veil.”
When bad times hit the corporate entity, it is easier to extricate owners from the corporation or LLC if they have maintained the corporate veil, which is to say they haven’t used company accounts, property or equipment for private benefit.
As with adequate capitalization, maintaining the corporate veil is both good for business and makes common sense.
Protection from creditors
There is another reason to maintain the corporate veil. After profits evaporate or after a costly lawsuit, creditors want what is entitled to them. If the corporation or LLC doesn’t have the assets to satisfy creditors, they will seek to pierce the corporate veil and gain compensation from owners’ personal accounts, property and equipment.
How can owners shield themselves from personal liability from company debts? The first step is to maintain the corporate veil and avoid intermingling company and private assets. Make sure all company business is conducted on accounts and letterhead that is clearly identified as being from the company, and personal business is clearly identified as personal.
While it isn’t imperative that owners respect corporate formality, they are advised that such informality doesn’t play well in court when creditors are suing for compensation.
And when it comes to corporate formality, nothing works better than adequate capitalization. Showing the court that the corporation or LLC was capitalized sufficiently for the business at hand goes a long way to maintaining the corporate veil.