For many successful business owners — from Mom and Pop at the corner store, to the directors of a multinational corporation — passion, dedication, and entrepreneurial spirit are fundamental elements of a prosperous enterprise. Unfortunately, however, every day many thriving businesses unwittingly fail to implement proper precautions against unnecessary expense and liability, thus jeopardizing everything that took so much work to build. The easiest, and arguably most important, way that business owners can safeguard their enterprises is through the proper creation and preservation of business records.
If you own or operate a business, it is imperative to recognize the importance of maintaining complete and accurate records of every transaction, agreement, or activity performed in relation to the business.
What Are “Business Records”?
Since the practice of maintaining thorough and accurate business records is so essential, it is important to understand what exactly business records are. “Business record” is a broad term for any written documentation (either hard copies or digital) made during the ordinary course of business that evidences transactions, agreements, negotiations, and other business matters.
Considering that so many documents readily fall under the “business records” umbrella, one may wonder exactly which records are crucial to produce and maintain. The short answer is: all of them. It is extremely beneficial to develop a habit of documenting every business-related activity, regardless of how trivial it may appear. The advantages are twofold: (1) business activities that currently seem trivial may turn out to be hugely consequential, making records of such activities equally critical; and (2) detailed (and organized!) documentation of prior business activities allows management to make well-informed decisions about future actions.
Although making a habit of creating and organizing detailed records relating to all business activities is valuable, several types of business record are especially important. These records include: financial records, contracts and agreements, and legal documents.
Maintaining complete and accurate financial records is an essential step in safeguarding businesses and their owners against potentially devastating liability. Some examples of a business’s financial records include balance sheets, profit and loss statements, cash flow statements, invoices, and receipts.
Dealing With The IRS
One of the major reasons why businesses must keep close track of their financials is for tax purposes. An incomplete or inaccurate picture of a company’s assets, debts, profits, losses, and other relevant information can result in serious tax consequences. For example, poorly-informed tax preparation can potentially result in accidental overpayment, or penalties and interest resulting from inadvertent underpayment. Incomplete financial information may also give rise to irregularities on business tax returns, increasing a company’s chances of being audited by the IRS.
Furthermore, in the unfortunate event one’s business is chosen for audit by the IRS, either randomly or otherwise, the extent to which financial records are (or are not) maintained, updated, and organized correlates with how painless (or how exasperating) the experience can be. Maintaining comprehensive and organized financial records allows a business under audit to quickly and easily produce any requested documents without wasting valuable resources in attempting to locate and verify them.
Defense Against Potential Personal Liability
Two of the most popular types of business entity in the U.S. are limited liability companies (LLCs) and corporations. One major reason that owners choose to organize their businesses this way is to protect their personal assets in the event their company incurs any financial liabilities. Any obligations — arising from penalties, damages, or debt enforcement proceedings — that are imposed upon these types of entities belong to the to the entity itself; they generally do not extend to owners or their personal assets.
There is one situation, however, in which LLC and corporation owners will be held personally liable for the debts of their business: when a claimant successfully “pierces the corporate/LLC veil.” Business owners can be held personally accountable for their company’s liabilities in situations where a court finds the company to be a mere “alter ego” of its owner — there is a lack of formal legal separation between business and personal financial affairs. This applies between parent companies and their subsidiaries as well.
Veil piercing claims are most successful against smaller, more closely-held businesses. However, they are usually less able to afford the extensive litigation. This is where carefully maintained business records become crucial. Prudent business owners can quickly dispense with a veil piercing claim by providing evidence of strict adherence to corporate formalities, a lack of intermingling of funds, sufficient capitalization, as well as other factors indicating a sufficient degree of separateness.
Contracts And Other Agreements
Operating a business necessarily entails transacting with various other businesses, and with customers themselves. For example, a business owner may contract with a property management firm for office space, vendors for materials, and even with law firms for legal services. For smaller, closely-held businesses, owners may be inclined to transact in a more informal manner. After all, in many instances, oral agreements and written contracts are equally binding and enforceable. However, there are several reasons why it is particularly important to do business through written contracts and agreements.
One downfall of doing business through oral agreements is the fallibility of human memory. Without a written copy, each party to an agreement may remember its precise terms slightly — or substantially — differently. Disagreements over simple contract terms can lead to costly litigation and soured business relationships.
Additionally, California law seriously limits the enforceability of many unwritten contracts. Commonly known as the “statute of frauds,” contracts for the sale of goods for $500 or more (Cal. Comm. Code § 2201), or contracts that cannot be completed within one year (Cal. Civ. Code § 1624) must be memorialized in writing and signed by the contracting parties.
As with a business’s financials, written contracts are another form of business record crucial to limiting disputes and maintaining fruitful, lasting business connections.
Another category of business record that business owners must be especially cognizant of includes legal documents relating to their company. Although the term “legal document” encompasses a broad range of written instruments, each plays an important role in a company’s continued operation. The California Corporate Code imposes varying legal formalities on each different type of business entity, and it is every business owner’s responsibility to adhere to these requirements. Common types of legal documents include the documents creating the company (i.e., articles of incorporation or articles of organization), documents establishing a management framework (i.e., bylaws and operating agreements), documents recording important business interactions (i.e., meeting minutes), and various other legal documents related to business operations (i.e., board/shareholder resolutions and ratifications, authorizations to issue stock, and a myriad of other essential legal instruments).
Strict adherence to legal formalities is essential for a business owner to limit potential personal liability. For example, keeping accurate minutes of all management meetings shows how business decisions were reached and whether they were made on an adequately informed basis. Furthermore, to ensure uniform assent to important business transactions, board members or shareholders may signify their approval with a ratification document. In the unfortunate event that an action is brought against a company challenging certain business dealings, prudent owners will have these records to shield them from liability arising either from allegations of unauthorized actions, or failure to maintain a corporate separateness.
However, all the advantages and protections afforded by consistent creation and maintenance of legal business records are greatly reduced if they are improperly drafted. Even the most seasoned business owners may not know precisely how to create these documents to meet their individual business needs, and may unwittingly jeopardize everything that they have worked so hard to build. When it comes to preparing legal documents, an experienced business attorney is essential. Comprehensive knowledge of the law and meticulous preparation allows business owners to breathe easy knowing that their businesses are well-protected.
Don’t Gamble With Your Business
As this article demonstrates, the successful and sustained operation of a business requires consistent creation and maintenance of many types of business records. It may not come as a surprise that many additional types of business record also exist. The business attorneys at Boyd Law are highly qualified and have the experience to identify and address any risks caused by record-keeping deficiencies. In addition, Boyd Law’s robust business practice allows us to establish enduring relationships with our clients, who have come to rely on our expertise in a wide array of business law matters.
TAX ADVICE NOTICE: To ensure compliance with the requirements imposed by the United States Treasury and IRS, we inform you that any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of: (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing, or recommending to another person any transaction or matter addressed herein.