Protecting Your Business with a Limited Liability Company
Posted: Tuesday, July 01, 2008
by Stephen Nelson
Stephen L. Nelson, CPA
Business owners and investors often worry about protecting assets from creditors and lawsuits. Of course, sometimes, people worry too much. And careful management of a business or investment coupled with up-to-date liability insurance policies may, in some circumstances, be all a person needs.
However, most business owners and investors should consider the three powerful forms of asset protection that the limited liability company provides. In some circumstances the asset protection provided by a limited liability company can prevent personal or business catastrophe.
Putting a business or an investment into a limited liability company is the most popular LLC asset protection technique.
By putting your business or an investment into an LLC, for example, you won't be personally liable for things that happen to or inside the business or investment simply because you own the business or investment.
In comparison, if you directly own or you together with other partners own a business or investment--in a worst case scenario--you can find yourself liable for bad stuff that happens merely because of ownership or co-ownership.
For example, suppose a business you directly own breaches a contract. If the party damaged by the breach sues the business and you're operating as a sole proprietorship or a general partnership, you might be forced to pay personally any damages because you're an owner or co-owner.
In comparison, if you own an interest in an LLC that, in turn, owns the business, you probably won't be liable for the business's debts (unless you personally promised to guarantee the LLC's debts or to guarantee the contract). Segregating Internal Business and Investment Risks
A slightly more sophisticated asset protection technique uses multiple limited liability companies to segregate business or investment risks into different containers.
For example, suppose that you're a real estate investor that owns six rental properties, and you've placed all six rental properties into one limited liability company. In this situation, you won't find yourself liable for bad things that happen inside the LLC merely because you own the LLC.
For example, if someone slips and falls at one of your rental properties, you probably won't individually be held liable for any damages that the LLC has to pay because of the accident. However, if you have valuable assets inside the limited liability company--say the equity in the six rentals--something terrible occurring at property four might destroy all the wealth you've accumulated inside the limited liability company.
In other words, if legally the LLC has done something "wrong," all of the assets owned by the LLC may be used to satisfy a creditor or to resolve an actual or threatened lawsuit.
If you place each property into a separate limited liability company, or if you setup a parent limited liability company and then place a single property into a separate child LLC, in comparison, a worst-case scenario means you lose only the single property inside an individual LLC.
Obviously, losing a single property might still be a disaster. But invariably losing just one property would be (using my example) better than losing six properties.
And, just to make this point, note that this segregation of assets into different LLCs isn't applicable only to real estate investors. A business owner might also segregate assets into different LLCs. A restaurant owner with three locations might put each location into its own limited liability company. A business might group product lines, business units or even customer groups into different LLCs.
Protecting Against External Business and Investment Risks
One remaining asset protection technique provided by a limited liability company should be mentioned.
In a worst-case scenario, a personal lawsuit might mean you lose ownership of property. Such property could easily include small business assets or real estate investments. That property could include the assets you use in a small business or the stock you own in a small business corporation.
Note: Often state debtor protection laws and federal bankruptcy laws mean that some of your personal assets are protected. Retirement accounts, life insurance, a modest amount of home equity, and your work tools are probably protected, for example.
In many states, however, an ownership interest in a limited liability company often can't be seized or transferred. Often, the best a creditor can do, for example, may be to get a "charging order" from a court. A charging order simply (and only) says any payments which should go from the LLC to the LLC owner should instead go to, say, the creditor. The "charging order" protection isn't perfect. But "charging order" protection does mean that you improve your negotiating position in any worst case scenario situation.
Neither the court nor the creditor with a charging can interfere with the operation of the LLC, for example. The court can't, for example, force the LLC to make payments to the LLC owner.
What this all means is that by owning assets or a small business through a limited liability company, you reduce the possibility that some external, personal event will foul up the stuff going on inside the limited liability company.
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Stephen L. Nelson, a Seattle area CPA, publishes the do-it-yourself limited liability incorporation and incorporating a business web sites.
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Top-level comments on this article: (1 total)Depending on the nature of the business and the tax situation, a corporation (whether C-Corp or S-Corp) would also serve to protect your personal assets. It's a good idea to consult both an attorney and an accountant before choosing a legal entity for asset protection.
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