As the adage goes, “You aren’t in business until you’ve been sued.” As litigious as society is these days, you don’t even need to be one of the bad guys to be dragged into court.
By simply transacting business with the general public, you open yourself up to myriad potential lawsuits, and no matter how arbitrary the complaint is, the destruction (and legal fees) it leaves in its wake can be crippling.
The states know that if entrepreneurs were forced to put their livelihoods at stake every time they started a new venture, significantly fewer businesses would be started. Therefore, certain entity types are afforded limited liability, which protect the owners and managers of the business from being held personally responsible for the debts, obligations, and misdeeds of the business.
Out of all the entities, limited liability companies (LLCs) offer the most comprehensive form of this protection.
An LLC protects you from the liabilities that you inevitably come across during the normal, everyday course of business. If your business gets sued or goes bankrupt, your personal assets (home, car, investments, and so on) and other businesses (if they are placed in different LLCs) cannot be taken away. Only the assets included in the LLC that got sued are at risk.
An LLC’s veil of liability protection is not infallible. If you don’t take certain measures to establish and maintain that your LLC is not simply an extension of yourself (your alter ego), then a court can disregard the LLC and allow a plaintiff or creditor access to your personal assets. This is referred to as piercing the veil of liability protection.
Forming an LLC to protect your personal assets must be done in advance, not after you’ve already been sued. Too many victims of lawsuits have shown up at my office wondering what they can do to get out of them — asking how they can save their home and bank accounts that are about to be taken away.
Unfortunately, at this point, it’s always too late. If only they had spent some time planning, they could have saved everything. Luckily, you’re off to a good start.
The one exception to the normal protection of LLCs is professional limited liability companies (PLLCs), because personal responsibility is essential to being a licensed professional.
By establishing your new business or placing your existing business in an LLC, you sign your company up for the most cost-effective, ironclad insurance policy around. A business insurance policy may still have a role in keeping the business itself from having to pay for its own misdeeds.
However, they’re effective only in lawsuits arising from product or service liability and usually don’t pay out to unsatisfied creditors if the company can’t meet its debt obligations. Also, whereas insurance companies can be wishy-washy about paying out, the LLC is pretty fail-safe.
Here’s the clincher: LLCs are so foolproof that attorneys often opt to negotiate a settlement or, better yet, avoid the time and cost of suing LLCs in the first place!
Although an LLC shields you from being held personally responsible for minor negligent acts, it does nothing for egregious criminal acts or willful misconduct. Also, the LLC does offer some protection against certain government creditors, such as the IRS, with one main exception: As a member or manager of an LLC, you can be held personally responsible for the failure to pay payroll taxes.
Therefore, if you withhold taxes from your employees’ checks and for some reason fail to submit that money to the tax man, you put your personal assets at risk.
