Any time you start a business, you’re courting risk. One of the most significant risks is that legal action could imperil your financial wellbeing, potentially jeopardizing not only your business assets but your personal ones, as well.
Imagine this scenario. You’re a business owner, and your business is hit with a lawsuit from an unhappy customer who alleges your product caused them harm. It could also be a disgruntled ex-employee claiming mistreatment, or an associate saying you ripped them off somehow. They claim significant financial damages, and the court sides in their favor.
The problem? The damages total more than the assets your company actually possesses. In this situation, you might rightly fear that the court will try to seize personal property: Your individual bank account or retirement account. The family car. Even a home that you share with your spouse and your children.
What, if anything, can business owners do to safeguard their personal finances? The best preventative action is to choose the right legal framework for your business, specifically setting up a limited liability company, or LLC. This is the most popular legal entity among America’s small business owners, and one of the main reasons for this is the built-in safeguards against personal financial ruin.
What is an LLC?
So what is an LLC, exactly?
An LLC is a business structure that actually creates a separate legal entity; in other words, it establishes the business as something that’s distinct from the business owner. This differs from a Sole Proprietorship or a Partnership, two other popular options for small business owners. With either of these structures, the owner(s) can claim all of the business profits as their own, but they are also personally on the hook for the business liabilities and losses.
Not so with an LLC. When you choose an LLC, you get to keep your business assets and personal assets separate, and similarly, you can maintain a distinction between business losses and liabilities and your personal ones. This is what provides the safeguard against personal financial loss… but more on that in a moment.
Some other quick facts about LLCs:
- In establishing an LLC, you will need to choose a registered agent to receive all tax and legal documents on the business’ behalf, selecting from well-known services like Northwest Registered Agent. See Northwest Registered Agent reviews for more information about this.
- LLCs are nominally more complicated to set up than Sole Proprietorships, but only because a Sole Proprietorship basically requires you to do nothing. Applying for LLC status will require you to file Articles of Organization with your state, and to pay some minimal fees on an annual basis.
- LLCs are also noteworthy for offering a lot of tax flexibility, allowing you to be taxed on a pass-through basis or to opt into the corporate tax rate if you so choose.
How LLCs Safeguard Your Personal Finances
To understand how LLCs safeguard your personal finances, let’s return to our previous scenario. What happens if someone brings a lawsuit against your business, but that business happens to be an LLC?
In this situation, the lawsuit would target the business and all business assets. But because there is a clear legal distinction between the business and the owner, you don’t have to worry about your personal assets being up for grabs. In fact, LLCs safeguard personal assets from both lawsuits and from creditors. What this means is that, with very few exceptions, the court will never be able to seize your money from your personal account, or property that you share with your family.
Shoring Up Your LLC Safeguards
What are the exceptions? In rare circumstances, the courts may take action to “pierce the corporate veil,” which basically means casting aside your LLC protections to seize personal assets. This really only happens if there is credible evidence that you have committed fraudulent behavior somehow.
To avoid this, and to ensure your personal liability protections are as strong as possible, there are a couple of steps to take.
Open an LLC Bank Account
It’s critical to have a business bank account that’s separate from your personal bank account. Not only does this make it easy to keep business funds and personal funds separate, it also makes it easier to track and write off business expenses.
Keep Funds Separate
The rule of thumb: Never use personal funds to pay off business debts, and never use business funds to cover personal expenses. By abiding by this rule, you will ensure your personal liability protections are as robust as can be.
LLCs Keep Your Personal Assets Safe
Launching a business means taking on risk… but by choosing the LLC structure, you can keep your personal financial risk to a minimum.
Cover Photo by Ofspace LLC