Separate the Financial Affairs for Each Entity

April 13, 2006

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In order to avoid application of the alter ego theory, not only must an owner separate personal and business affairs, but also separate activities among different business entities.

When funding and structuring a small business, we advocate the strategy of using a holding entity and an operating entity. In addition, the small business owner also may want to consider forming multiple operating entities, one for each distinct area of the business. Court decisions have made it clear that the entities will be recognized as separate from each other, and from the owner, even when there is one common owner who manages each entity.

However, care must be taken to ensure that the principles of forming a limited liability company (LLC) or statutory close corporation, separating and documenting ownership of assets, and then holding required meetings are applied separately to each entity.

Thus, each entity should hold title to its own assets. These assets should be contributed to the entity in exchange for an ownership interest. The contributor should take back ownership certificates in his/her or its name (the holding entity may be the contributor, and thus the owner, of the operating entities). Each entity should also have separate bank accounts and credit cards in its own name, its own Records Kit, and its own accounting system.

Note that a single accounting software package can be used for multiple separate entities. Each entity is simply accounted for as a separate file within the system.

Where ownership and management overlaps among the entities, the owner also must ensure that he acts individually for each separate entity. Separate recordkeeping systems and separate documentation can help ensure that this is the case.

Under the Delaware LLC statute, when multiple entities are created under a single LLC, special care must be taken to ensure that each entity is recognized as separate and distinct. Each unit should be designated with a name in the articles of organization, and this name should be used in all of the transactions affecting that unit. The unit should be operated in the same way it would be had it been established as an unrelated LLC.