Let’s discuss the first reason why it might make sense for you to put up a Corporation. The first reason is Personal Invincibility. When I teach this concept to workshop students, I do it by referencing my favorite military innovation in recent years: the predator drone.
Drones are small planes armed with missiles and guns flown to engage targets and to do recon work. The best thing about them? They have no pilot. They are flown from halfway across the world by soldiers in secure locations.
The commands are bounced off orbital satellites and the drone performs as if the pilot were really there in the cockpit. There is no performance lag when you compare the pilot being there in the cockpit versus when it is being controlled from halfway across the world.
Why is this significant? Well, the upside is that you get to keep your soldiers away from danger. If the drone gets in trouble or gets shot down, your personnel are left unharmed. The hardware takes the brunt of the damage, and your pilot walks away to fight another day.
Corporations allow you to operate, but you are miles away from danger
The same thing happens when you operate thru a corporation. You are the brains behind the operations – the pilot. The corporation is the drone. You choose what you want to invest in the drone and you send it out into the battlefield called “business operations in real life”.
The corporate-drone is treated as a separate entity by the law. It can make maneuvers, engage the enemy (or competitors) in business all you want. If by some chance it fails in its mission (it dies or goes bankrupt), only the drone (or the corporate assets) would be casualties.
You, as the pilot operating it from miles away, walk away unharmed because only the corporate assets on the battlefield were in play.
How it plays out in real life
Let’s imagine a businessman by the name of Mr. Jay. Mr. Jay owns:
- 5 Million Pesos in Cash
- A Car worth 1.5 Million
- A House worth 10 Million
Mr. Jay decides to put up a corporation with his friend, Mr. Patrick. He names the company Jay Inc. and decides to sell detergent to coin-operated laundry shops around Metro Manila.
Mr. Jay decides that Php 500,000 capital would be enough to give the corporation a running start so he invests Php 500,000 into the corporation thru stocks. The game plan is that with this working capital, the business would be able to get enough momentum and income so they can be self-sufficient in the future.
Jay has remaining assets which he can invest (cash, house, and car), but he decides that the initial capital would be enough so he keeps these assets out of the company. They push thru with the plan and go thru with the grand opening.
After a year, the company ran into cash flow problems. Their major customer closed up shop without paying them. As a result, they were left unable to pay off their own suppliers. Here’s the golden question: if the business then has debts, who foots the bill? Will Jay’s personal assets be at stake?
The suppliers know Jay personally. They know that Jay is asset rich and he has a house and car in his possession. They call Jay and say, “You owe us! We’ll go after you and your stupid car and your stupid house and all the cash you have!”
Here’s where the corporate protection kicks in.
What the supplier/creditors need to understand is that since they were dealing with the corporation, Jay as a person is out of the picture. The law says that the people dealing with the corporation are limited to recovering only from the assets owned by the corporation.
Of course, the creditors will howl, “You own Php 500,000.00! You own a car! You own a house! Use that to pay us!”
Nope. Despite appearances, the law says that the 500k cash, the car, and the house belong to Jay personally. They have nothing to do with Jay Inc. in this instance.
The suppliers may say, “But, but… it was jay dealing with us all along! he attended the meetings, he attended the contract signing… he did it all! Therefore, he should be responsible for this!”
Let me ask you this: did Mr. Jay do these things in his personal capacity or did he do so as a representative of the company? In other words, “who” were you dealing with when you entered into the contract? Was it Mr. Jay as himself, or “Mr. Jay” on behalf of the corporation?
What does the law have to say?
Even if it was physically Jay doing the work and talking to you, from a legal standpoint, Jay was covered by the mantle of protection of the company. As far as the law is concerned, you were dealing with Jay Inc. and not Mr. Jay so all recovery concerns should be directed to Jay Inc.
Are you getting this? When you operate under a corporation, the law considers your corporate transactions separate from your personal dealings. Therefore, if something goes wrong, only the assets which you chose to invest in the company are at stake. The rest of your fortune is kept safe. This lends you “personal invincibility”. The legal term for this concept is called the doctrine of Separate Juridical Personalities in case you want to read up on it.
Again, just to recap, if you operate as a company, your personal and corporate assets are considered separate. Even if Jay personally owns all of these assets, there is no legal basis to seize them unless you can show that these were owned by the company.
To recap, when does it make sense to operate as a company? If you want to compartmentalize your life, then a corporation is the perfect vehicle to do so. If you want to limit your exposure in a new business venture, then create a corporation so that the only thing you risk is the amount you put in.
Hope you learned a thing or 2 here, keep tuned for the next post, where we tackle the issue of control.