You and a friend want to start a business but you don’t know if you want a partnership, a corporation, or a limited liability company (LLC). Someone told me that if we create a business entity, we can protect ourselves from personal liability? What does that even mean?
If you open a business and your business is sued, depending on how the business was created, you personally can be obligated to pay for any judgment that is awarded to a plaintiff. This means that you and your friend can lose the money in the business’ accounts, plus your personal bank accounts, your car, even your home may be at risk.
Or, you may have hired employees and called them independent contractors so you wouldn’t have to withhold taxes or pay benefits. A disgruntled ex-employee calls the Labor Department who investigates your business. They determine that you misclassified the people who work for you and they are employees under the law. Therefore, you owe back wages, back taxes and a large fine. Your company must pay the back wages, back taxes, and the fine out of the company bank accounts but if there is a shortage, you and your partner may need to pay them out of your personal assets.
This is why I counsel my clients to avoid general partnerships when starting a business. There are no protections from personal liability with a general partnership. Your personal assets are always at risk and you could lose all the wealth that you carefully saved and invested.
If you and your partner form a corporation or an LLC, even if the corporation or LLC does not have enough assets to pay a judgment or back taxes, or fines and penalties in full, no one can come looking at your personal assets for payment. You must be careful to keep the business entity separate from you and your partner by signing documents as a representative of the entity, keeping personal assets and expenses separate from the entity assets and expenses, holding required meetings (for corporations), and keeping business entity filings up-to-date.
If you behave illegally or act beyond the scope of the activities allowed by the business entity, you can still be personally sued. But, for most legal problems, the business entity will shelter you from personal liability.
