This guide outlines how to safeguard your private assets with LLC liabilities as a business owner.
All business owners must be aware of the potential for legal action against them. Under the default business structure, known as a sole proprietorship, your personal assets have no protection.
The Limited Liability Company (LLC) is the single most powerful tool entrepreneurs have to protect their personal assets from legal action. Unfortunately, with the number of small businesses reaching 32.5 million in the USA, many entrepreneurs lack the necessary protections given with LLC liabilities.
Here’s what you need to know about safeguarding your personal assets as an LLC owner.
Why you need LLC liabilities protection
Forming an LLC means creating a business entity that remains separate from you, the owner. The separation is how limited liability protection exists in the first place.
If your LLC cannot pay its debts, the LLC’s creditors have the right to go after its bank account and any other assets registered under its name. Your personal home, car, and bank accounts are safe from such action.
There are limits on how far your LLC liabilities protection will take you. For example, if you personally guarantee any debts, have unpaid payroll taxes, or are sued because of wrongdoing specific to you, your personal assets could be at risk.
Understanding where your LLC liabilities protection’s limits lie is vital for crafting a strategy that keeps your personal assets safe.
How LLC Insurance Protects Your Business
Personal liability will not go far enough to shield you if someone files a lawsuit against your business accusing you, the owner, of wrongdoing. Examples where your LLC liabilities won’t protect you from personal liability including defrauding a customer, crashing a company vehicle, or being negligent regarding building maintenance.
A comprehensive insurance policy will protect you and your LLC if you’re sued. In addition, proper business protection will include a public liability policy to protect you as an individual.
It is not uncommon for lawsuits to involve both the LLC and the owner of the LLC. Remember, an LLC liability protection is not 100% comprehensive.
Maintain Separation Between You and Your Business
Corporate law has a lot of grey areas. One aspect that is not a grey area is mixing personal and corporate assets. It may be challenging as an owner, but you must view your LLC as its own entity.
Mixing your assets can make you liable as a designated “alter ego” of your business. In addition, some recent cases have shown that courts may extend the liability of the LLC to the owners of said LLC if asset mixing occurs.
To avoid this problem, the records of the owner’s finances and the LLCs should be separate and distinct. For example, your LLC should have its own bank account, credit cards, and any contracts must be in the name of the LLC.
Practicing these habits early will ensure that everyone you do business with knows they are doing business with an LLC, not you.
Establish Your LLC’s Credit Early
Perhaps the biggest reason why entrepreneurs unwittingly become liable for their company’s obligations is that they give personal guarantees. Personally guaranteeing any lease or loan means you agree to make any payments when the LLC cannot.
Some lenders may require you to make personal guarantees to secure business loans. It explains why only 57% of business loans are approved. When you’re starting, your LLC will have no credit history.
Pay your bills on time, take out small amounts of business credit, and be consistent to avoid needing to make personal guarantees to secure funding in the future.
There are no shortcuts to building up business credit. The same principles of improving your credit score apply to your business as they do to your personal credit rating. Establishing your credit will take time and effort, but the sooner you start, the sooner you can reach an “Excellent” credit score.
Be Aware of Asset Distribution
If your LLC is sued, creditors have the right to go after the business’s assets. However, with an insurance policy, you will likely not have to worry about losing your LLC because your insurer will cover the bills.
However, you should still consider the worst-case scenario. Limit your vulnerability by using and distributing liquid assets accordingly.
Many LLC owners keep as little money as possible within the company and making distributions to the owner. Note that there are tax implications to increasing LLC distributions and payments, so it pays to speak to a tax accountant first.
Maintaining only what the company needs to function and investing or distributing the rest prevents you from losing more money than necessary if a lawsuit is lodged against you. The moment any profits have been passed through to the owners, they are now personal assets, and creditors cannot go after them.
There are aspects of this strategy you need to be aware of. Firstly, if you are already in debt to a creditor and move money out of the company, this would be classified as a fraudulent transfer and can get you into serious trouble.
Moreover, if you cannot keep enough money within the company to meet its expenses, judges can hold you personally liable under the “alter ego” rules. Purposely undercapitalizing your business will be viewed as an attempt at defrauding your creditors.
Both situations could lead to you becoming personally liable and, in some cases, criminally liable. There is a fine line to tread with LLC liabilities, so make sure you speak to a professional about your circumstances to stay compliant with the law while mitigating your vulnerabilities.
Conclusion
Starting an LLC and establishing a separate legal entity for your business is one of the best moves you can make to defend your personal assets. The LLC liabilities protection doesn’t make you immune, however.
Taking out LLC insurance policies and ensuring sufficient liability protection provides an added layer of defense should someone decide to sue. What steps are you taking to protect your personal assets from potential litigation?
