Does your bucket have a hole in it?

Risky business: managing risk in the small business world

Once someone knows that you are a reader, they will ultimately ask you, “What’s your favorite book?”

Now, this is never an easy question, and it seems that I always have to stop and think before giving an answer. And I usually lay-up by providing a list instead of a definitive title. This list is constantly evolving as I continue to read more books. But one book that always makes the list is Charlotte’s Web by E.B. White.

Charlotte’s Web is one of those classic books that requires rereading throughout life. It can be equally enjoyed by a small child and a grown adult. I remember reading this book aloud to my children before they were old enough to read for themselves. I am sure my daughter dreamed of being Fern, rescuing the runt pig from her heartless father. Meanwhile, I was thinking about John Arable, yielding to the pleas of his little girl to have mercy on Wilbur.

Towards the end of Charlotte’s Web, there is a chapter titled “Uncle”. The chapter takes place at the fairgrounds, where Wilbur has been taken to compete in the County Fair. When the family arrive, Fern and her little brother, Avery, immediately want to go have some fun. So their dad gives Fern two quarters and two dimes. Avery is given five dimes and four nickels. The money has to last all day. The kids are then allowed to go out to the fair all alone for the day. They only have to come back to the truck for lunch.

Mrs. Arable questioned John if it was okay to let the kids run around the fair alone. “’Well, they’ve got to grow up some time,’ said Mr. Arable. ‘And a fair is a good place to start, I guess.’” At this time in the story, Fern is eight years old.

Now I know that most parents would not allow their eight-year-old daughter and her younger brother to roam around the County Fair alone in this day and age. And it is quite easy to lament the lost innocence of today’s society.

Instead, I think it is important to remember that even in the innocent 1950’s, there were risks – hold on tight to the swings, watch for pickpockets, don’t cross the race track when the horses are coming. Similarly, small business risks have always been around. The important thing is to know what the risks are and to plan accordingly.

Business risk and the small business owner

For small business owners, the risks differ depending on your location, industry, and various other factors. These risks are generally easy to identify for the small business owner. For instance, the owner of a trucking company understands the risks associated with having multiple large trucks on the road. At any given moment, an innocent person could be seriously injured by a company employee driving a company truck. Insurance policies are used to protect the business assets from these business risks.

On the other hand, business owners use various types of legal structures to protect their personal assets from business risk. To explain this to business owners, I often compare their legal structure to a bucket. Suppose a business owner creates an LLC for their operating entity. I refer to this LLC as their bucket. Anything within the bucket is subject to the business risk. You protect the items in the bucket with insurance. As long as your bucket does not have any holes in it, then everything outside of the bucket is protected by the LLC.

Going back to the trucking company, suppose the company is a corporation. Should the company experience a loss due to an accident with one of their trucks, insurance should cover the loss. If the insurance is inadequate, then the assets of the company will have to cover the difference. However, the personal assets of the business owners should remain protected from the loss.

The devil is in the details

That is how things are supposed to work. The problem arises when the small business owner fails to maintain their corporate structure by not filing all tax returns and annual reports with the proper state agencies. When you fail to file these required forms, the state can often administratively dissolve your corporation or LLC. Once dissolved by the state, you are no longer considered a corporation or LLC for legal purposes. Therefore, you are no longer protected personally from liabilities arising within your small business. You have a hole in your bucket.

Related: The one way to absolutely, positively ruin your business

Legal liability is not the only thing that is affected by this situation, as one small business recently learned the hard way. In November 2016, the U.S. Tax Court issued Tax Court Memorandum 2016-198. In the memo, the court granted a motion by the Internal Revenue Service to dismiss the case for lack of jurisdiction. The motion was granted because the charter of the corporation was suspended by the California Franchise Tax Board. Because of this, the court determined that corporation lacked the legal capacity to prosecute the case.

In the memo, we learn that the corporate charter had been suspended since 2008. During that time, there was actually no corporate protection for the shareholders. Any liability incurred by the corporation over the normal course of business could have affected the shareholders. This is a situation that you will want to avoid as a small business owner. By not maintaining your corporate structure, you are creating more risk for yourself and your small business.

Protect your small business

So how do you maintain your corporate status? You have to pay attention to the little things:

  • Hold an annual meeting. Most states require corporations to have an annual meeting to elect officers and directors. Minutes must be kept of the meetings. Most attorneys will assist you in maintaining your required notices for the annual meetings as well as the documentation for your minutes.
  • File all required tax returns and pay your taxes. In North Carolina, the Department of Revenue can suspend your corporate status for failing to file tax returns and pay all necessary taxes. Be sure that your small business is filing all tax returns timely, including income, employment, sales and use, and franchise taxes.
  • File your annual reports. In addition to filing your tax returns, most states require corporations and LLCs to file an annual report with the Secretary of State or equivalent state office. An annual report fee must be paid with these reports. Failure to file the required annual report and pay the fee is usually grounds for suspension or administrative dissolution.

There are other ways that small business owners expose themselves through risky behaviors within their business. This article’s main focus in on maintaining your corporate structure. Stay tuned for future articles on risky business behaviors to avoid. In the meantime, remember that ultimately, it is up to the small business owner to be smart in their business decisions.

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About David

About David

David is an accountant and adviser for small business owners. He also coaches clients on leadership and success. David is an avid reader. He blogs regularly on the books that he is currently reading.

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