With free enterprise, economic freedom and asset management being such hot topics these days, growing numbers of entrepreneurs are setting up corporations here in the U.S. and abroad. In my opinion, there is no better authority on the rules of the corporate-formation landscape than Garrett Sutton.
Garrett is an attorney who has been in practice for over thirty-five years, assisting entrepreneurs and real estate investors globally in protecting their assets. Garrett has the distinction of being a part of an elite group of Rich Dad Advisors, through best-selling author Robert Kiyosaki, who is known for his perennial best-selling book, Rich Dad Poor Dad.
I reached out to Garrett after reading his book Start Your Own Corporation, and he was kind enough to grant me 45-minutes of his time to talk about current and emerging trends concerning business formation. Below is a Q&A transcript of our discussion.
Garrett, thank you for your time. Can you briefly start off by telling us a little about your journey into the world of corporate formations?
Michael. My journey began in Northern California where I attended U.C. Berkeley for undergrad before heading over to Hastings College of Law in San Francisco. After becoming a California attorney and determining that the Bay Area was becoming too crowded for me, I decided to move to Reno, Nevada, and take the bar exam there so that I could be closer to Lake Tahoe, one of my favorite places.
I’ve always had an interest in corporations, but I found there were a lot of people who really didn’t understand them. So in addition to starting my law practice, I decided to write a layman’s guide to corporations. As I was starting to write the book, I became acquainted with Robert Kiyosaki and the Rich Dad/Poor Dad group. My book then became a part of their series.
I’ve actually read Robert’s book Rich Dad, Poor Dad years ago, when it was on the way to becoming a bestseller.
That’s great. I have to say that being associated with Robert and his positive message of financial independence has been a huge boon for me personally. This connection with him has really helped my book – Start Your Own Corporation – gain credibility with a fairly wide audience.
In Chapter 2, entitled Good Entities, you break down the various types of business entities and their pros and cons. Can you offer a brief overview of this?
Sure. When I travel around the country and around the world, I like to frame entities as The Good, The Bad and The Ugly. The Bad is the sole proprietorship. The Ugly is the general partnership where liabilities often exist times-two. In the book, I encourage the use of good entities, which are S and C Corporations, LLC’s, and LPs which stand for Limited Partnerships. The reason they are good, Michael, is because these good entities provide the owners with limited liability protection. This is the asset protection you want when doing business because, unfortunately, lawsuits occur all the time.
So what’s so bad about a sole proprietorship or general partnership?
Michael, the bottom line is that operating as a sole proprietorship or general partnership leaves all of your personal assets exposed. Setting up an LLC, a Corporation or LP, allows you to protect your personal assets – like a house or a car – from being exposed to a claim against your business. So that’s why I always encourage people to use the good entities.
Does this hold true even for new business owners who are just starting out?
With all due respect to the accounting field, you often hear CPAs tell their clients that are just starting out that they really don’t need to set up a corporation or LLC. I personally disagree with that type of thinking because even though you are just getting started, the risk of getting sued is still there. And if you are the sole proprietor and someone sues you, a judgement can be renewed against you every seven years. So if you set up a good entity like a corporation or LLC from the start, you can prevent that from happening. This is why I always encourage people, even if they don’t have a lot of income at the start, to use a good entity.
I remember reading in your book about the various corporate formalities involved with managing a business. So what does a new business owner need to remain mindful of?
You raise a key point. When you separate yourself personally from the business, you have to follow the corporate formalities dictated by the State you filed in. This typically involves paying the necessary fees each year to the Secretary of State’s office and maintaining annual meeting minutes. Moreover, it’s important for contracts and agreements to be signed in the name of the business. In other words, shouldn’t sign a contract with just your name; you sign it with your name as “President of XYZ Corporation, Inc.” For at that point the world knows that they’re doing business not with you the individual (where you could be personally liable), but rather with the corporation which gives you limited liability protection.
As I understand it, there are also different tax ramifications associated with these various types of entities. What can you share here?
My Rich Dad Advisor colleague, Tom Wheelwright, gets into this whole area in his book Tax Free Wealth. But let me say this, as a business owner, it’s important to have a team of advisors to guide you through all of this. Here you have an attorney giving you the asset protection advice in collaboration with a CPA like Tom who delivers the tax advice. They need to come to the table as a team, working to ensure that you’re getting sound advice.
I’ve noticed that there has been a proliferation of online businesses offering to help a newly minted business owner incorporate in any one of the 50 states. What do you think of these?
That’s a good question. I would say at the start that a prospective business owner needs to exercise a bit of caution here. I’ve seen situations where people have received bad advice on what business entity to use, which can have major ramifications down the road. In fact, in my book I caution readers that sometimes these services don’t offer everything needed to get set up correctly. While the price may be cheap, it may not provide the full measure of corporate formality you need. So just be careful when utilizing one of these services.
Garrett, there is much discussion about the value of setting up a corporation in states like Nevada, Wyoming, Delaware, South Dakota and Texas. What’s the story here?
One of the trends we’re seeing across the nation is that courts are not giving protection to the single member LLC, particularly when that business owner owes money to someone else. However, there are five states that continue to protect single member entities: Nevada, Wyoming, Delaware, South Dakota and Alaska. So setting up entities in these states will continue to be popular.
What about the expense associated with setting up an entity in a particular state?
The State of California definitely stands out in terms of cost, as they are the most aggressive at collecting their annual $800+ franchise fee. In fact, even if you are from out-of-state, and you do business in California, you will likely see a bill. This has become an expensive proposition for those California residents who own a lot of state entities as well as entities outside of the state. So any time you have a California resident doing business outside of California, or a resident outside of California doing business in California, there is much more extra planning needed to meet California’s requirements.
In general, filing fees amounts vary from state to state. Nevada just raised theirs, but at the time of this interview, we don’t know how much it’s actually increasing. Wyoming, which is a very good state in terms of it’s protections, is only $50 per year. So you kind of get to pick and choose where you want to get set up.
So how does it really work if a business owner has an entity in one state but chooses to have a second entity in another?
Here’s how this works. Let’s say you have a Colorado LLC but because Colorado is not the strongest asset protection state, you choose Wyoming which is far better. There are two ways to do this. One way is to establish a Wyoming LLC and qualify it to do business in Colorado. That would require you to pay the Wyoming corporate entity fee and then pay the Colorado Secretary of State for permission to do business there. Another way to do it is to set up the LLC in Colorado, pay the Colorado filing fee, but have the Colorado LLC be owned by a Wyoming LLC. This scenario offers far superior asset protection than having a single entity here in Colorado.
In your book, you talk about a concept called the “corporate veil” where you underscore the importance of following proper incorporation formalities. Can you walk us through this?
Sure. The corporate veil is what protects you as an individual from being held responsible for the corporation’s liabilities. So let’s say you enter into a business deal through your corporation and the corporation gets sued. If you follow the formalities, then that’s where the suit ends. On the other hand, if you don’t follow the formalities, the veil of protection between the corporation and you as the individual falls apart, and the person suing the corporation can get through to you, the individual.
What type of formalities are required?
These formalities include maintaining annual minutes, where each state requires you to have a meeting once a year and a record of the meeting minutes. You also have to pay the annual filing fees to the state as well have what is know as a registered agent that resides in the state. Then there is the issuance of stock certificates, a requirement that not everyone follows. It is particularly important to issue these stock certificates to keep the corporate veil in place. Often the IRS is all over those entities that don’t issue stock certificates or haven’t kept meeting minutes.
So how concerned should a business owner be if they haven’t followed these formalities?
Well, let me put it this way. If you fail to follow these formalities, the veil of protection comes down, and you can be held personally responsible in the event of a lawsuit. The fact that the percentage of successful veil-piercing cases is 50% suggests that business owners need to pay close attention to this.
I’m curious as to whether assets like physical gold and silver can be protected through corporate formation?
We have a number of clients who have bullion – physical gold and silver – and that’s very easy to record as an asset through an LLC. I also know people who have auto collections, trademarks, and patents recorded in an LLC. So there are a number of ways to use an LLC to protect personal assets. And here again, it is particularly helpful to have this entity set up in a protected state like Nevada or Wyoming.
In closing, can you offer a few ‘crystal ball’ predictions in terms of emerging trends in the business formation space?
I hope my crystal ball is not cracked [laughter]. The trend that I mentioned earlier about the decline in asset protection among single member LLCs is one that I think will spread. We are keeping a close eye on this and have alerted our clients so that they are aware. Another trend I think we’ll increasingly see are states like Nevada raising their filing fees because, frankly, I don’t see states becoming less hungry for tax revenues.
At the end of the day, I hope there continues to be an interest in corporate formations and entities because we need people starting businesses and employing their fellow Americans. That’s something which will help this country prosper, over time.
Michael Scott is a book publicity content strategist located in Denver, Colorado. http://allthatbookjazz.com More on Garrett Sutton can be found at sutlaw.com. And his book can be easily found at Amazon.com