Entity Theory

You own a small business. You work and sweat at it...20 hours a day, seven days a week. It's basically your whole life. You and your business are inseparable. You make a really cute couple.

Well, not according to entity theory. Entity theory states that the business activities of a company and the business activities of its owners should remain separate.

So, for instance, even though you own 100% of the business, you shouldn't pay your mortgage out of the company's revenue. You can pay yourself a salary, and then pay your mortgage with the money from that salary. But you shouldn't just treat the company's coffers as your personal piggy bank.

Or vice versa. If the company is having trouble, you shouldn't start paying company bills with your personal savings. You can invest your personal savings in the business, maybe for some additional equity. Or you can loan the company money, if you choose. But there needs to be a formal separation between the business and you as the owner.

Entity theory is important because it creates the idea of limited liability. See: Limited Liability Corporation. This concept states that the business can only lose as much money as the investors have put into it. That way, creditors can't go after the individual owners if the business fails. They can't put a lien on your house, for instance, if your ice cream and salsa food truck goes belly up.