I often get asked, “Now that I am an LLC or corporation, I am completely, 100% protected from personal liability, right?” Well, um, how do I put this delicately? Uh, no. No, you are not. “Wait, what!?” It is because the company isn’t an impenetrable shield. It is more like a really high wall that is difficult but not impossible to surmount. So when do you become liable?
The first way should be pretty obvious: When you say you are personally liable. Those personal guarantees make your personally liable. Same with co-signing a loan. That makes sense. You are not liable unless you say you are. That’s why banks and landlords like getting personal guarantees. If the LLC fails and can’t pay, they can go after the owners for the payment. If they did not get a personal guarantee, then it is much, much harder to go after the owner for the debts of the LLC.
The second is when you stop acting as a good owner of your company. You may be held personally liable if you are found to have committed fraud such as making fraudulent representations or omissions when applying for a business loan or you created the LLC to further a fraudulent cause or business. Unsurprisingly, courts don’t want to say that you can now hide behind the LLC wall to avoid liability. Same is true if you try to use your company’s assets for your own good. You want to pay for a fancy resort vacation for you and your extended family? Don’t say it is a “business trip.” If you would be mad that your partners were doing it, or would sneer at the story on the news, then assume you are making your it easier for you to be found liable instead of the company.
Other things are a bit more subtle. You need to treat the LLC as a separate entity. It has a separate bank account, separate credit cards, and you don’t pay business expenses with your personal money nor do you pay personal expenses with the business’ money. If someone can’t tell where you end and the company begins, then you are going to have problems saying why you should be shielded.
Also, that means the LLC is going to have to act like a good LLC. That means filing its annual reports, having meetings and resolutions (even more important if your business is a corporation), accurately track investments and capitalizations, signing contracts as the business – not as an individual. All the things that make the company a company, you have to do. If you don’t want to act like a company, why should you be treated as one?
In short, creating the entity is just the first step in limiting your liability. Acting like a company is the next step. Third, be sure to get insurance and proper contracts in place to help cover costs and mitigate risk. And finally, realize that in life and it business, nothing is risk-free, but if you follow the rules, you will reap the benefits.