Is your business formally incorporated?

Incorporating can help ensure that in times of trouble, your personal assets are secure even when your business assets are under threat. But that’s not enough.

Once incorporated, you need to employ the best practices to keep your corporate status intact. That’s because courts and regulators can sometimes find reasons to wipe it out.

Lawyers call it “piercing the corporate veil.” When it succeeds, it can be devastating to a business owner who thought his or her personal assets were protected.

Why It Happens

Don’t panic. Veil-piercing isn’t some kind of random strategy taken out against just business owners. It happens for a reason. Typically, it’s because the business or its owner are suspected of committing some sort of fraud — against a customer, vendor or financer, or the government.

Failing to deliver a service that’s been paid for, cheating on taxes and lying to the bank are obvious examples. But under the law, business fraud also includes any spending or investment of corporate funds that is reckless, irresponsible or dishonest.

Any of those misdeeds can bring your business to the attention of authorities, who may then try to undo your corporate structure. But well-meaning businesses that wind up on the bad end of a big lawsuit may also be in jeopardy. If a plaintiff wins a big judgment against your company — and if there are questions about how separate your personal assets and finances are from the corporate entity — that may present an opportunity for an aggressive attorney to question, and try to undo, your corporate status.

Besides fraud or losing a big lawsuit, other factors can lead the court, a plaintiff’s lawyer or the taxman to try to rip away a company’s corporate protection.

One is too much debt. Consider a business that’s financially so deep in the hole it can never hope to reasonably pay back the money it owes — whether to suppliers or to the government. The creditors are going to look for ways to get back at least some of what they’re owed.

The flip side of that is too little startup cash. The business term for this is “inadequate capitalization.” It’s not a crime to start up your company with little or no money, but if the unfunded company looks like a pretense — perhaps a phony shell set up to hide the owner’s income from some other venture — and the court catches on, the company’s corporate status will be at risk.

Staying Safe

The obvious way to avoid any of these troubles is to make sure your business is adequately capitalized, pays its bills on time, and stays well on the right side of the law and ethical business practices.

But just as always driving safely doesn’t guarantee you’ll never have a car crash, maintaining a sound business — although it’s absolutely critical — isn’t always enough to keep you out of trouble.

So the other half of protecting your corporate status is to do just that — protect it. That means you simply take a number of common-sense steps that show the world you and the company really are two separate entities. How?

1. Follow corporate formalities. Don’t just pay the fee, sign the papers and file them with the state office where corporations are registered. Keep up that registration each year (or however often your state requires it to be renewed). And do all the other things that your state requires of corporations.

2. Keep personal and corporate finances separate. This is such a basic rule we shouldn’t have to repeat it here — but in fact, a lot of startup business owners violate this one. Your business should have its own bank accounts, its own investment accounts — even its own credit card, if you find having a business credit card useful.

Also, never co-mingle your business finances and your personal ones. Don’t pay the mortgage for your house with a check from your business account. Don’t use a personal check to pay for supplies you pick up for your business.

Finally, when it comes to taking payments from the company, you’re better off establishing from the start a systematic payment schedule. In short, put yourself on a salary. Better yet, establish a written payment agreement between the business and you — and have your board sign off on it.

It’s easy, and probably tempting, to fall into a pattern of just transferring excess cash from the business account to your personal account as you find you need it. But that can also be a red flag for anyone trying to prove you and your business really aren’t separate from each other.

Set up formal policies as well for other financial matters, like how your company makes purchasing decisions and how you decide when to borrow money. Finally, make sure you subject the business to regular audits with a properly certified or licensed financial professional.

3. Be ethical — and set an example for employees. Don’t just try to practice your ethics by the seat of your pants. Set forth some basic principles, stick to them, and make sure everyone who works for you understands them and follows them as well.

Incorporation is a valuable form of protection for your business, and for you and your family. By following these simple guidelines, you can help ensure that protection does all it’s supposed to.

Then, instead of a flimsy corporate veil someone can easily rip down, you’ll have a long-lasting safeguard: a shield as strong as steel.