What does an LLC's limited liability really protect you against (if you are sole owner and employee)?

Question

I have looked into forming an LLC a few times in the US (right now I am better off not doing so for tax reasons while I am abroad but that is another story). However in my research, I may be misunderstanding something but I couldn't find much that the limited liability actually protected against.

1. For bad business dealings the freelancer is negotiating personally, he may still be sued in addition to the LLC so it isn't clear to me that provides much protection, and

2. Most banks would have required that I co-sign any loan for the business, thus ensuring I wouldn't be able to run away from business debt.

From what I looked at it did look like some business debts would be harder to forcibly collect against anything other than business assets but those would only be likely to be smaller routine debts (buying things on business credit for example).

So what I concluded was that at least in the US, limited liability looked like it protected investors from loss, and business partners from eachother, but didn't offer much protection for the sole principle business owner. Am I far off on this? Am I missing something major?

Answer 1

An LLC protects you from personally from all creditors, whether they be customers, shareholders, or other parties. Liability for business activities is limited to the LLC's assets; yours are protected.

Nolo's LLC Basics describes this well:

Like shareholders of a corporation, all LLC owners are protected from personal liability for business debts and claims. This means that if the business itself can't pay a creditor -- such as a supplier, a lender, or a landlord -- the creditor cannot legally come after an LLC member's house, car, or other personal possessions. Because only LLC assets are used to pay off business debts, LLC owners stand to lose only the money that they've invested in the LLC. This feature is often called "limited liability."

As you will see if you keep reading on their web page, there are exceptions to the limited liability, such as unfair, illegal, or fraudulent activity. These are, however, exceptions. The fact that a bank asks you to personally co-sign a loan is a demonstration of the strength of the LLC's protection: the bank knows that if your LLC defaulted, the bank would otherwise be limited to collecting only the LLC's (insufficient) assets.

Answer 2

It should be remembered that with any form of Limited Liability structure (LLC, Ltd, PLC) etc the liability is limited only to the shareholders or members.

In the event of a company failing, other than losing their investment, shareholders/members are only liable for any unpaid share purchase money (or nil, if all shares are fully paid up).

Beyond that, anyone may have further liability:

• The directors and office holders have a fiduciary duty to operate the company within the law, and can be held personally liable in the event of non-compliance.
• Within many professions, there are rules to comply with - whether imposed under statute, or by the Professional Bodies. Non-compliance may result in you being"struck off" or lose your approval to operate.
• Any individual employee has an obligation to act professionally at all times, and can be personally liable in the case of negligence - hence the general recommendation to maintain Professional Indemnity insurance.

Of course, in the case of a freelancer, you wear all of these hats. But a key skill to learn is to recognise which hat you are wearing, and when.

Answer 3

Edward Brey's comment is pretty much spot as far as liability is concerned. Other than (well put, Edward!) illegal activity, the LLC form protects the owners and operators from incurring personal liability as a result of activities carried out for the business of the LLC.

The LLC business entity is a simpler approach than a corporation because it removes the need for shareholders, annual meetings, and so forth. Taxwise, an LLC (in the US) can register as a sole proprietorship (single-member LLCs), partnership, or corporation as far as how the taxes are processed. An LLC can buy, sell, and transact just like a corporation or a living person.

I've heard of some real cool approaches to having LLCs. Celebrities establish them to hold title to their residences (it keeps the paparazzi away, because the celeb's name is not in the public tax roll). In certain states, buying certain types of property is taxed heavily when being sold to a living person, but taxed less heavily when sold to an LLC (motor homes, for example). With as little as it costs to form an LLC (Wyoming costs $50), the advantages are many.

As far as loans are concerned (I used to work for a lease broker for business equipment) the big deal is that with a loan made to an LLC (or corporation), its operators can disappear with the proceeds and the lender has no recourse for a "dead" business entity with no assets and no income. That's the reason why they require a living, breathing body to co-sign for new business entities. A living, breathing person can be JAILED (smil e), whereas the business entity cannot. This is standard practice until the business entity builds credit in its own name, which is not easy to do.

When I worked for the broker, there were countless people I'd talk to who'd fill out applications and want to do everything "in the name of the business" and be adamant about not co-signing -- and they'd get turned away. The most adamant ones were, to no large surprise, the ones with lousy personal credit.

Answer 4

I think it's valuable to add to the other answers that you must be able to prove that your LLC is acting as a business entity in order to have the protection specified.

Generally speaking you do this by running it as a real business and not as a shield.
(Meaning that, in most cases, you can not simply have an LLC but give it no capital, keep no books, etc... and expect any protection.)

The following seems to be a good rundown on a lot of specific things you can do to make it legally clear that your LLC is actually a business: http://www.elizabethpottsweinstein.com/llc-protect/

Hope that helps.