Own Your Own Corporation By Robert Kiyosaki.
Bad Entities
Sole proprietorships
General partnerships
Case No. 1—Johnny
Johnny was a plumber. He had been at it for five years and was starting to succeed. His
customers were satisfied with his work and the word of mouth for Johnny’s Ace Plumbing was
good.
While Johnny was a good plumber, he felt intimidated by legal matters. Lawyers and
accountants were supposed to be smart, so the work they did must be difficult. When Johnny was
a young boy his father had been unfairly treated by a lawyer. He remembered it to this day, and
wanted nothing to do with them.
So instead of consulting with a professional on how best to conduct his business, Johnny let his
part-time bookkeeper select an entity off the menu. The results were disastrous.
Johnny’s part-time bookkeeper knew only that forming a corporation required filing special
documents with the state but did not know how to file them. He knew that a corporation needed
to file a separate tax return but was not sure of the ins and outs of preparing one. And so he
suggested Johnny use a sole proprietorship because he knew how to handle one and always
suggested one for his clients. One size fits all.
The problem was that a sole proprietorship provides absolutely no asset protection. By
operating as a sole proprietorship Johnny has unlimited liability for the debts, claims, and
obligations of the business. This unlimited liability meant that his house and savings and personal
assets were exposed to the claims of others.
Of course, as in all horror stories, a demon entered Johnny’s business. He had hired Damien
as an employee to assist with his growing workload. Damien seemed like a decent guy and
appeared to know the plumbing business. Johnny did not bother to do a background check on
Damien. Johnny was new to the business world and not aware of the need to do so.
After one week on the job, Damien assaulted one of Johnny’s customers while they were alone
in her house. Without going into the sordid details, this woman was so severely traumatized by
what Damien did to her in her own home that she and her family had to move away.
Within three weeks of the incident Johnny’s business was sued. Because Johnny was a sole
proprietor, this meant that he , and not the business itself, as with a corporation, was sued and
had to defend himself.
The lawyers suing for the woman did the background check of Damien that Johnny did not do.
Damien was a recently released ex-convict with a history of sexual assaults. Johnny did not have
the insurance to cover such a claim. The case went forward. The lawyers argued to a jury that
Johnny’s business was irresponsible for failing to check up on Damien and was responsible for the
consequences. They presented to the jury what was true—a business is vicariously liable, or
responsible, for the acts of its employees. The jury was horrified by the whole case and awarded
damages of $10 million.
Johnny was wiped out. As a sole proprietor he was completely and personally responsible for
every claim the business incurred. And he had attorneys with a one-third contingent interest in
the collection of $10 million after him.
Johnny lost his house, his savings, and his family. The stress of it all resulted in his wife
divorcing him, obtaining custody of the children, and moving away. Johnny declared bankruptcy.
He ended up a broken man despising lawyers and our legal system all the more.
The irony, of course, is that by consulting with a lawyer and using the legal system to his
advantage, Johnny could have prevented the disastrous consequences that resulted from relying
on a part-time bookkeeper with a one-size-fits-all mentality for entity selection.
A competent lawyer would have told Johnny that there were risks—known and unknown—in
running any business. To protect yourself from such risks you need to limit your liability by
establishing a corporation or other good entity.
A good entity is one that shields and protects your personal assets from business risk. A bad
entity is one that provides you no protection whatsoever. By using a good entity Johnny could
have used the legal system—which has evolved to encourage business activity and limit the
liability of risk takers—to his advantage.
Good Entities
C corporations
S corporations
Limited liability companies (LLCs)
Limited partnerships (LPs)
Sole proprietorships
General partnerships
Case No. 1—Johnny
Johnny was a plumber. He had been at it for five years and was starting to succeed. His
customers were satisfied with his work and the word of mouth for Johnny’s Ace Plumbing was
good.
While Johnny was a good plumber, he felt intimidated by legal matters. Lawyers and
accountants were supposed to be smart, so the work they did must be difficult. When Johnny was
a young boy his father had been unfairly treated by a lawyer. He remembered it to this day, and
wanted nothing to do with them.
So instead of consulting with a professional on how best to conduct his business, Johnny let his
part-time bookkeeper select an entity off the menu. The results were disastrous.
Johnny’s part-time bookkeeper knew only that forming a corporation required filing special
documents with the state but did not know how to file them. He knew that a corporation needed
to file a separate tax return but was not sure of the ins and outs of preparing one. And so he
suggested Johnny use a sole proprietorship because he knew how to handle one and always
suggested one for his clients. One size fits all.
The problem was that a sole proprietorship provides absolutely no asset protection. By
operating as a sole proprietorship Johnny has unlimited liability for the debts, claims, and
obligations of the business. This unlimited liability meant that his house and savings and personal
assets were exposed to the claims of others.
Of course, as in all horror stories, a demon entered Johnny’s business. He had hired Damien
as an employee to assist with his growing workload. Damien seemed like a decent guy and
appeared to know the plumbing business. Johnny did not bother to do a background check on
Damien. Johnny was new to the business world and not aware of the need to do so.
After one week on the job, Damien assaulted one of Johnny’s customers while they were alone
in her house. Without going into the sordid details, this woman was so severely traumatized by
what Damien did to her in her own home that she and her family had to move away.
Within three weeks of the incident Johnny’s business was sued. Because Johnny was a sole
proprietor, this meant that he , and not the business itself, as with a corporation, was sued and
had to defend himself.
The lawyers suing for the woman did the background check of Damien that Johnny did not do.
Damien was a recently released ex-convict with a history of sexual assaults. Johnny did not have
the insurance to cover such a claim. The case went forward. The lawyers argued to a jury that
Johnny’s business was irresponsible for failing to check up on Damien and was responsible for the
consequences. They presented to the jury what was true—a business is vicariously liable, or
responsible, for the acts of its employees. The jury was horrified by the whole case and awarded
damages of $10 million.
Johnny was wiped out. As a sole proprietor he was completely and personally responsible for
every claim the business incurred. And he had attorneys with a one-third contingent interest in
the collection of $10 million after him.
Johnny lost his house, his savings, and his family. The stress of it all resulted in his wife
divorcing him, obtaining custody of the children, and moving away. Johnny declared bankruptcy.
He ended up a broken man despising lawyers and our legal system all the more.
The irony, of course, is that by consulting with a lawyer and using the legal system to his
advantage, Johnny could have prevented the disastrous consequences that resulted from relying
on a part-time bookkeeper with a one-size-fits-all mentality for entity selection.
A competent lawyer would have told Johnny that there were risks—known and unknown—in
running any business. To protect yourself from such risks you need to limit your liability by
establishing a corporation or other good entity.
A good entity is one that shields and protects your personal assets from business risk. A bad
entity is one that provides you no protection whatsoever. By using a good entity Johnny could
have used the legal system—which has evolved to encourage business activity and limit the
liability of risk takers—to his advantage.
Good Entities
C corporations
S corporations
Limited liability companies (LLCs)
Limited partnerships (LPs)
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