We recognize that many small business owners often operate with various informal agreements. However, we want to ensure you recognize that it is frequently important to formalize an agreement with a legal contract. For example, any agreement upon which you rely that can affect the future of your business is important enough that it should be formalized.
Among other things, contracts allow both parties to clearly define their obligations and expectations to and from one another, establish (and potentially limit) their liability, set forth payment terms, and allow each party to understand its responsibilities.
A legally valid contract has four basic components:
- A meeting of the minds. Both parties understand and agree to the essential elements of the arrangement.
- Consideration. Something of value must be exchanged by each of the parties. This can be in the form of money, goods, or even a promise to do something.
- An agreement to enter into the contract. A written contract signed by both parties satisfies this requirement. (Oral agreements can also be valid in certain circumstances.)
- Legal competence. Each party must have the capacity to enter into the agreement, meaning each must be of sound mind, and neither can be a minor.
While most contracts address specific items, such as payment terms, timing issues, and the exact subject of the agreement, the above four components are a critical starting point. Remember, if it’s important enough to cause you to wonder, it’s probably important enough to formalize the agreement.
Taking the time to put together a solid business plan that includes your plans, strategies and goals for your business can make the difference between the success or failure of your company. In fact, according to Dun & Bradstreet statistics, poor planning is the number one cause for failure of small businesses.
Your business plan should give a meaningful description of your business. Think of it as a tool to help grow your company, and to monitor your company’s performance over time. In addition, investors will typically want to review your business plan to determine whether to invest in your company.
Don’t worry that you can’t foresee every twist or turn your business will take, and be prepared to modify your business plan as you go along. Do, however, be realistic in the assumptions you make while drafting your business plan. Your business plan conveys a lot about both you and your business, so make sure you approve of the message it sends.
One of the most attractive features of a corporate structure is limiting the personal liabity of the company’s shareholders (or members in a limited liability company). But simply incorporating your business is not enough; it does not automatically protect you from your company’s creditors.
Generally a corporation’s creditors can’t sue its shareholders for their personal assets (limitied liability). However, in certain instances courts will allow the creditors to pierce the corporate veil and do exactly that. For example, courts sometimes allow piercing the corporate veil in instances of fraud or similar wrongdoing, not allowing the shareholder to hide behind a false or flimsy corporate veil.
It is important to adhere to corporate formalities, and treat the corporation as a separate entity. (You and the corporation are NOT one and the same.) Properly document transactions between the corporation and its shareholders, officers and directors, and make sure the transactions are fair and reasonable and in accordance with applicable corporate law.
Though piercing the corporate veil is not terribly common, it is important to protect yourself against even the possibility of losing your limited liability.