A Limited Liability Company (LLC) is a business structure that helps entrepreneurs separate their company assets from their personal assets.
When you establish an LLC as a business owner, it becomes an independent legal entity able to conduct business, enter into contracts, and own assets like real estate in its own name.
This means that only the assets controlled by the LLC, and not your personal assets (home, car, stocks, personal savings, investments, etc.), are in danger of being taken to settle a claim against your business if your LLC accrues debts or legal liabilities, including creditor claims, lawsuits, and bankruptcy.
For example, imagine that you own an LLC that operates a landscaping business. If one of your employees damages a client’s property, and the client successfully sues your business for damages, your personal assets would generally be protected from the lawsuit. Only the LLC’s assets, including its bank accounts, equipment, and company property, could be recovered to cover claimed damages.
If you had registered your landscaping company as a sole proprietorship, your personal assets would be totally exposed if your company is unable to pay the whole cost of the lawsuit on its own.
This is because in a sole proprietorship, the business and owner are treated as one legal entity, and as a result, you may be sued and held personally accountable for any debts and liabilities the business incurs.
When Can’t an LLC Protect Your Personal Assets?
Most of the time, an LLC keeps your personal assets out of reach from creditors or unhappy clients who sue you.
However, there are some situations where LLC personal asset protection may not apply. Here are a few illustrations:
You Form an LLC Too Late
Without establishing an LLC, you’re probably running your business as a sole proprietorship.
As I previously stated, sole proprietors are liable for any debts, liabilities, and court judgments incurred by the business.
The protection offered by an LLC will not apply to pre-existing liabilities or claims if you create a limited liability company after your sole proprietorship business has already accrued sizable debt it can’t pay or been sued. At this point, your house, car, personal bank account, and other assets are still at risk as a result.
Therefore, we recommend that you form an LLC as soon as possible if you’re operating a business to protect your personal assets from the dangers associated with running it. An experienced local business lawyer can help you properly set up your business as a limited liability company when you launch it.
You’re Personally Guaranteeing Business Loans and Obligations
It is common for business owners to offer personal guarantees that a loan they take will be repaid to secure financing for their company, particularly if their business is flourishing or has recently launched.
As the owner of an LLC, you should refrain from providing personal guarantees because by doing so, you forfeit the asset protection that an LLC offers to your personal assets by promising to cover any debts that your company defaults on out of your own pocket.
For example, if you guarantee a loan that your landscaping company takes out to buy equipment, but the company is unable to make the loan payments, your lender may sue you and take your house, car, savings, and other assets to recover their money.
When you start your business, we understand that you may be forced to use your home or other sizable assets as security for the financing you need to expand your company. However, as your business grows, there are things you can do to make sure you don’t inadvertently make yourself responsible for your business debts, including:
- Understand the Risks. Make sure you fully understand the financing terms and any potential repercussions if your limited liability company fails to uphold its responsibility before signing any business loan documents. It’s always a good idea to get legal counsel when signing any legal documents, especially when it comes to business contracts.
- Explore Alternative Financing Options. If a lender or creditor demands a personal guarantee before approving your application for a business loan, consider exploring other forms of funding for your company. For example, you could ask friends and family for a loan or apply for an unsecured loan.
You could attempt to negotiate the terms if you really need the money, and your only option is a lender who requires a personal guarantee. For instance, you may be able to persuade them to accept a limited personal guarantee, which would only make you responsible for a percentage of the company’s debt rather than the entire amount.
Negotiating that they leave out specific assets, for example, your home, can also help you reduce your risk when offering personal guarantees for your business liabilities.
- Build Your Company’s Credit Score. Create a business account when you form your LLC and use it to conduct frequent transactions to demonstrate that your company generates recurring income.
Apply for loans in the company’s name using this account as well, and make sure to make the repayments on time. As your business credit score improves over time, you should eventually be able to get loans for your company without having to give personal guarantees.
- Only Use Your Business Title When Signing Contracts. If you simply sign your name on loan paperwork without designating yourself as your LLC’s representative, for example, it could be assumed that you’re personally guaranteeing the loan, and you could be held accountable if there is a breach of contract.
You Fail to Pay Certain Taxes
A limited liability company protects your personal assets from the majority of business tax liabilities, but if you fail to pay payroll taxes, the government may confiscate your home, vehicles, and other personal assets to cover any payroll taxes owed to them.
You Engage in Illegal Activities or Are Negligent
Let’s say, for example, you run an investment LLC and you commit securities fraud.
An LLC doesn’t provide protection for personal assets where a business owner has engaged in unlawful or fraudulent conduct. So, if you’re caught, the personal assets you acquired with the illicit earnings made performing this crime, can be liquidated to recoup the money your investors lost.
Also, let’s assume that you’re a real estate limited liability company owner who isn’t doing a good job of maintaining your properties.
If someone is hurt while in your building and sues your business for their injuries, this negligence might cost you dearly. Because negligence that results in harm or damage to another person isn’t also covered by LLC protection, and in such a scenario you might be held personally accountable for the injuries caused to the person.
You Fail to Observe LLC Rules
Many small and medium-sized businesses conduct personal and business transactions through one account. For example, they could ask customers to deposit business payments into their personal accounts or pay LLC invoices using personal checks.
If you’re a business owner who engages in this practice, stop commingling your funds immediately, or you could be providing creditors an opportunity to easily take possession of your home, personal funds, investments., etc.
How is this possible when you have an LLC to safeguard your personal assets? There is a legal concept known as “Piercing the Corporate Veil“, which allows a court to disregard the legal separation between an LLC and its owner, essentially treating your business as a sole proprietorship.
A court can pierce the corporate veil if you’re sued and you fail to prove that you observed LLC formalities like maintaining separate business and personal bank accounts, holding annual board member meetings, keeping business and personal financial records separate, etc.
When a judge pierces the corporate veil, your personal assets may be used to pay off business debts and legal obligations.
Gallagher Krich, APC: Experienced San Diego Business Lawyers
Do you want to ensure that any challenges that may arise while operating your business don’t negatively impact your personal assets? Schedule a free consultation with one of our business attorneys by calling Gallagher Krich, APC, at (858) 926-5797 or filling out our online contact form to learn how to successfully keep yourself and your company out of legal trouble.
With over 30 years of combined legal experience, our experienced business attorneys can help you with everything from creating an LLC or any other type of business entity to adhering to business regulations specific to your sector, protecting your intellectual property rights, and selling your company.
90% of businesses are involved in a legal tussle at some point in their existence. So, don’t wait until it’s too late – contact us today, and let’s work together to ensure legal problems don’t wipe out your personal assets or hold your business back!