Piercing the corporate veil occurs when a court decides that a business is not operating as a legal entity that's separate from its owners. When the veil is pierced, it can put the owners' personal assets at risk. Establishing habits designed to maintain separation early on demonstrates that your company is functioning as an independent entity, and this can help minimise potential legal and financial exposure for founders.

Below, we'll go over what "piercing the corporate veil" means, common reasons courts choose to pierce it, and how founders can take steps to create and maintain separation and avoid piercing the veil.

Key takeaways

• The legal separation between a company and its owners is called the "corporate veil."

• The corporate veil is designed to protect company owners' personal assets from being used to pay company debts and legal obligations.

• Courts can decide to "pierce the corporate veil" and hold owners personally liable for the company's debts when the company disregards that separation or cannot prove it in court.

What does 'piercing the corporate veil' mean?

The "corporate veil" is a term used to describe the legal separation between a company and its owners (e.g., founders, shareholders) and directors. "Piercing the corporate veil" occurs when a court disregards that separation, typically due to misconduct.

When the corporate veil is pierced by a court, the company's owners and directors can be held personally responsible for the company's debts. This can leave their personal assets, such as homes, cars, and bank accounts, exposed.

Why does the corporate veil exist?

The corporate veil exists to protect the personal assets of a company's owners and directors. When someone forms and registers a corporation or limited liability company (LLC), it creates a separate legal entity that's distinct from the individual and anyone else who owns and manages the business.

Other business structures, such as sole proprietorships, do not provide the same level of protection. This can make incorporation an attractive option when starting a business.

In the US, courts generally respect this legal separation and will only pierce the corporate veil under limited circumstances, such as fraud or injustice. When the veil is pierced, the court can order assets belonging to a company's owners and directors to be used to settle company debts.

What are some common reasons courts pierce the veil?

Courts consider many factors when deciding whether to pierce the corporate veil. Qualifying factors typically involve serious misconduct and are usually weighed collectively rather than in isolation.

Laws vary widely between states, but here are some common reasons for piercing the veil.

Commingling personal and business funds

In corporations and LLCs, personal and corporate funds must be kept separate. When personal and company assets are blended to cover expenses or the business fails to maintain distinct financial records, the business risks having a court pierce the veil.

Failing to maintain corporate formalities

Corporations and LLCs must follow specific formalities and practices, including holding board meetings regularly, keeping minutes, and adhering to board bylaws. When these formalities are not observed, it can signal to the court that the company is not functioning independently from its owners and result in a decision to pierce the veil.

Undercapitalising the company

A court is likely to pierce the veil in situations where the company uses undercapitalisation to deceive creditors. Undercapitalisation occurs when a corporation is not adequately capitalised to cover ordinary business operations during its formation. It can also occur when there's not enough funding to cover the company's ongoing operations.

Using the entity to commit fraud

When shareholders participate in fraudulent activities, misrepresentation, or use the corporation to conceal fraud and other acts of dishonesty, the court might decide to pierce the veil.

Committing injustices

The court can choose to pierce the veil to prevent an unjust action by a corporation that would result in unfair results for third parties, such as creditors.

What practices help reduce the risk of piercing the veil?

There are certain practices you can put in place in the early days of your business to help ensure appropriate separation between personal and company assets. Consider these tips to avoid piercing the corporate veil:

• Keep corporate assets separate from the owners' personal assets: Maintain financial separation by opening a business bank account and using a business credit card. Never commingle personal and business expenses or banking accounts.

• Provide adequate capitalisation: Sufficiently fund your LLC or corporation at its inception, and provide ongoing funds to support operations. You can use your own funds, a business loan, or investors to fund the company. Just be sure to direct all capital for use by the business, not its owners.

• Follow all formalities: Closely observe formalities outlined in your operating agreement, and comply with applicable state laws for your corporation or LLC. This might include creating and regularly updating bylaws, issuing shares of stock, and holding annual meetings for directors and shareholders.

• Document key business decisions and actions: Record all major decisions in writing, and keep copies of any contracts or formal business documents for at least seven years. Keep minutes for all major meetings, such as initial and annual shareholder meetings. Note the meeting date, attendees, and key decisions made.

• Demonstrate your business status: Display your business name clearly on company materials, including business cards, invoices, and other formal documents, such as leases.

Why does maintaining separation matter most for early-stage founders?

During the early stages of a startup, founders might be more prone to commingling personal and business finances – especially when operating at a fast pace and performing multiple roles at once. Establishing good habits early on can help reduce future legal and financial exposure as the company grows and takes on more risk. It's key to keep assets separate when signing leases, taking on debt, entering into contracts, and executing other business activities, as it helps courts distinguish between the company's and the owners' assets.

If a business owner is unable to provide proof that their company is operating as a separate entity, a court might decide to pierce the corporate veil, leaving the owner's personal assets at risk.

A self-audit checklist for maintaining separation

As a business owner, you can use this checklist to help ensure your company is following best practices when it comes to establishing and maintaining separation:

• Does the company have its own separate business bank account?

  • If so, are any personal expenses going through the business account?
    

• Does the company have a separate business credit card?

  • If so, is the card only used for business expenses?
    

• Is the company properly capitalised?

  • If so, are all funds properly designated for the business, not the owners?
    

• Is the company documenting key decisions and other matters appropriately?

To help ensure your business is maintaining separation, revisit this checklist at least once a year or before any major financing or transaction. You can also consult an attorney if additional guidance is needed.

How Stripe Atlas can help

Stripe Atlas handles everything you need to legally launch your company – incorporation, employer identification number (EIN), equity setup, and tax filings – so you can fundraise, open a bank account, and start accepting payments in as little as two working days, from anywhere in the world.

Join 100,000+ startups incorporated using Atlas, including startups backed by top investors like Y Combinator, a16z, and General Catalyst.

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Atlas files your EIN application automatically after incorporation. You don't have to wait – Atlas enables pre-EIN payments and banking so you can start accepting payments and making transactions right away. US founders with a Social Security number (SSN) are typically eligible for expedited Internal Revenue Service (IRS) processing.

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