The benefits of creating an LLC—as opposed to operating as a sole proprietorship or general partnership, or forming a corporation—typically outweigh any perceived disadvantages.
An LLC can shield your personal assets from debts and other liabilities incurred by your business. It also typically allows creditors to only go after your company’s assets (not your personal assets) should you be unable to pay your business’ debts.
There are, however, several circumstances in which business owners can be held personally liable, and you should understand how these potential pitfalls can leave you vulnerable.
If you’re thinking of incorporating your business, or if you already own a corporation or LLC, you should become familiar with the following scenarios that can leave you personally on the hook for your business debts.
Mixing Business & Personal Finances
The biggest risk to your business (and your personal assets) when running a small business is mixing your personal finances with those of your business. It can be something as benign as using a company bank account to pay your mortgage or depositing a check made out to your business into your personal account. If this is happening to you now—and we bet it is, because it happens to almost every business owner we serve—there’s no shame in it, but there could be major risk to you.
Mixing your business and personal finances means that if you are ever in a lawsuit related to your business and a judgment is obtained against your business, a court can decide that you’re using your company as an extension of yourself, and therefore you should be held personally liable for its debts. In that case, everything you’ve read or believed about your business entity protecting your personal assets just goes right out the window, and you lose all the protections of having that entity. On top of that, mixing business and personal finances means you will not be able to make wise strategic decisions based on the finances of your business, and that’s actually your biggest risk, bar none.
To prevent this, we at Truest Law, regularly review our clients’ financials with them and their accountant to ensure all finances are separate to protect their personal assets.
Making Personal Guarantees
If you cosign a business loan or personally guarantee a financial obligation for your corporation or LLC, you share responsibility with the company for paying it back.
Likewise, if your business defaults on a loan you’ve personally guaranteed, your company’s creditors can come after your personal assets, even if you have a business entity in place.
Using Personal Assets As Collateral
Since many small business owners don’t have a lot of startup capital, you may be asked to use your personal property, such as your home or other assets, as collateral on a business loan. If so, the personal assets you pledged as collateral can be seized and sold off to pay your company’s creditors in the event your company fails to pay back the loan.
Committing Fraudulent Actions
Of course, if you make fraudulent representations or omissions to secure a business loan, you can be held personally liable for those debts.
Similarly, if your corporation or LLC was created to further a fraudulent purpose or you made business deals knowing the company wasn’t able to pay for them, you can be convicted of fraud, thereby voiding your personal liability protection.
Keep Your Veil Intact
In light of all of the complexities surrounding corporations and LLCs, you should meet with our team to make sure you’re not opening yourself up to be personally liable for your business debts. We will not only help you decide which business entity structure is best suited for your operation, we’ll also assist you in properly setting up and maintaining the entity, so your personal assets are always well protected. Call us today to get started.