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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?

  • From what I understand, your company signs a contract and any liabilty, if sued, can only be taken from wht is in your companies assets (Money in account, company car, computers,etc) You personally, may be called to a civil court for negligence. But such cases are mostly made if you doing strictly secret work, and they accuse you of leaking information or something,or deliberly planting back doors, or malicious code. You should get PI Insurance just in case, as this is separate from Business Insurance. These cases usually end in jail time, if you are proven guilty :( – WillyWonka Apr 10 '14 at 21:43
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    An important note may be that a judge can easily determine that your LLC is not independent of the single-member and thus negating any protection the LLC may offer. You need to be diligent in keeping personal and business financial aspects separate. Don't buy personal stuff with LLC money. Take dividends on the business or write yourself a paycheck, but treat the money as if they are 2 separate entities with separate bank accounts and separate bills. – Scott Apr 16 '14 at 20:36
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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.

  • For major loans though, that is why banks require owners or officers to co-sign right? Thats what really sparked the question in my mind. – Chris Travers Jun 8 '13 at 8:34
  • A bank doesn't necessarily care if it's an owner or officer who co-signs. It could just be someone with enough collateral that the bank can recoup most of its losses if the business goes bankrupt. However, when a business decision maker co-signs, it makes the loan more attractive to the bank since it knows he has "skin in the game" and is likely to work harder to make the business succeed. Either way, the bank needs a co-signer since it knows the LLC protects personal assets if the loan is taken out in the business's name only. – Edward Brey Jun 8 '13 at 11:46
  • I am just saying that when I was looking into it in the US, all banks I talked to required all officers of new LLC's to co-sign, which more or less meant limited liability wasn't much of a limitation. – Chris Travers Jun 8 '13 at 12:44
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    Co-signing means you are personally liable to pay back what the bank loaned you, but you still are protected against claims from other parties. – Edward Brey Jun 8 '13 at 14:29
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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.

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    I believe the statement "the liability is limited only to the shareholders" is incorrect. The liability is limited to the corporations. The shareholders are specifically protected unless there is an exceptional circumstance. – Edward Brey Jun 7 '13 at 13:52
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    This is WAY off. An LLC doesn't have shareholders, it has members. Secondly, professionally bodies (doctors, attorneys) cannot register as LLCs - they have to register as professional corporations. Lastly, the other stuff about the "directors and office holders", or employees, is pretty much a given, wouldn't you think? – Xavier J Apr 8 '14 at 19:15
  • I concur with @codenoire. This statement is inaccurate... I just formed an LLC in Arizona, USA a few months ago. – daaxix Apr 10 '14 at 14:22
  • Incomplete, maybe, not innaccurate - so I've added "or members". But the point still stands - the limited liability extends to the investment only. – Andrew Apr 16 '14 at 18:59
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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.

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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.

  • Good point. A judge can easily determine an LLC is not viable and dissolve it instantly if you don't treat the LLC as an independent entity. – Scott Jan 27 '16 at 19:10

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