Will an LLC Protect My Personal Assets?
LLCs and Limited Liability
One of the main reasons people form LLCs when starting a business is to protect their personal assets. But if something happens, will an LLC actually protect your personal assets? It Depends.
Generally speaking, the LLC structure limits business owner’s personal liability. Limited liability means the owners of the LLC (also known as members) are not personally responsible for the debts and liabilities of the business. So members don’t have to pay out of their own pockets if the business loses a lawsuit. Similarly, if the business defaults on a loan, the members don’t have to dig into their wallets to pay it back.
The limited liability offered by LLCs comes from the fact that LLCs have legal personhood. In other words, an LLC is a separate legal entity from the people who own it. The company may enter into contracts, sue and be sued, and own property in its own name. Since the LLC is its own separate entity, the law generally doesn’t hold business owners responsible for the company’s debts. Which is why as the owner of an LLC, your personal assets are provided a level of protection from your business activities.
However, an LLC won’t protect your personal assets from everything that could go wrong…
Limited Liability Won’t Protect Your Personal Assets from Everything
There are some situations where an LLC will not protect your personal assets. Here are the most common situations.
Commingling Funds
Remember, the protection provided by an LLC comes from the fact that it is a separate legal entity. Courts will respect that separation, as long as you do as well. However, when business owners don’t treat their business as a separate entity, they can lose their limited liability. This happens most frequently when business owners start commingling funds.
Commingling funds means that you are treating money that belongs to the business as if it belongs to you personally. Money that is paid to the business belongs to the business, and you have to treat it that way. For example, a business owner who uses the same bank account to manage their business and personal affairs is commingling funds. When a client pays the business, that money should go into a separate bank account owned by the business. And the operating agreement should lay out how and when the business owner will be paid.
Business owners who commingle funds are ignoring the legal separation between themselves and their business. When you don’t respect the separation between you and your business, courts won’t either. And if you get sued, your personal assets may be up for grabs. This is called “piercing the corporate veil”.
Avoiding this fate is simple. After you form your LLC and put together an operating agreement, open a business bank account. Not only will this protect your assets, but it will also help you build a relationship with a potential source of credit for your business.
Personal Guarantees
Many people form LLCs because they want to take out a loan in the name of their business. By taking out a loan in the name of their business they hope to protect their personal assets if they can’t pay back the loan. For most new businesses, this is an unrealistic expectation. No financial institution is going to issue a loan without collateral. In order to feel comfortable making the loan, they want to know that they have a relatively easy way to collect if you default.
When you first start your business, your company will have no credit history. So unless your business has significant assets to put up as collateral (e.g., a building, valuable intellectual property, or a significant amount of cash), you’ll have to sign a personal guarantee. This means you’ll be personally responsible for the loan. So if you fail to pay it back, they can sue you personally and collect from your personal assets. In this case, your LLC will not protect your personal assets.
Personal Negligence
Last but not least, your LLC will not protect your personal assets from your own negligence. What does this mean? It means that if you harm someone due to your own carelessness, you will be sued personally. And your LLC will not protect your personal assets if you lose in court.
For example, let’s say you own a small grocery store. One day while working in the store, a customer informs you of a spill in aisle 4. However, instead of immediately having someone go take care of it, you decide to finish what you were doing. Minutes later, another customer slips and falls on the spill and breaks their hip. Because you were aware of the spill and the danger it posed to customers in your store, yet you decided not to take action to clean it up, your carelessness caused that customer’s injury. Not only will the customer sue your company, but they will also sue you personally. And if a court finds you negligent, your personal assets will be fair game.
Don’t rely on an LLC to Protect your Personal Assets
Bottom line, business owners shouldn’t rely solely on their LLC to protect them from risk. Risk protection is an important aspect of running a business. Entrepreneurs must be thoughtful about how they protect themselves. Insurance, written contracts and business planning all have important roles to play in protecting your business.
If you have questions about protecting yourself and your business from risk, let’s talk. MZA Legal is here to help new entrepreneurs and small business owners take advantage of new opportunities and protect what they’ve already built. If you need assistance, we’re here to help.