Launching your own business is an exciting time. But nobody wants to think about the consequences if things don’t go according to plan. You could have a flourishing business, and a lawsuit could destroy everything you’ve worked hard for.
That is the reality of the sole proprietorship and the general partnership. Of course, nothing requires you to incorporate it as a business, but it makes sense if you have significant personal assets.
Let’s discuss the personal liability protection offered by the Limited Liability Company (LLC) and how far these protections go.
Primary Liability Protection
Did you know businesses spend $1.2 million on average in litigation costs?
The fact is you’re highly likely to either be sued or to be threatened with a lawsuit at some point. In addition, if your business activities have made you liable, you will have to pay out-of-pocket costs if you’re not adequately protected.
The primary benefit of an LLC is that it protects your assets if your business incurs unsustainable debts or any liabilities resulting from lawsuits. Creditors will be unable to go after anything other than the assets in the LLC’s name.
Personal protection applies not only to the activities carried out by your LLC but also to the actions of your employees and co-owners. For example, if a co-owner performs an action that would pierce the corporate veil, your assets remain protected as long as you can prove that you had no personal involvement.
Should I Take Out Insurance for My LLC?
Your assets may be protected, but up to 90% of businesses will be sued at least once during their lifespan. Just because your assets are covered doesn’t mean a single nasty lawsuit can’t lay your business low.
Understand that protecting your livelihood means also defending your business’s assets. Failing to take out a comprehensive insurance policy will represent your business still has to cover fines, legal costs, and out-of-pocket expenses.
With a valid insurance policy in place, the insurer is the one that pays. Since practically every business will find itself facing litigation at some point, paying the regular monthly premiums makes sense because it’s an investment that will repay itself many times over.
Lawsuits that drag on may cost you a six or seven-figure sum. Can your company pay these costs out of its cash reserves?
Do your research and pick out a few policies. Then, weigh up different coverage options and make sure you always have insurance for an LLC.
Where Does Your Protection End?
Your liability protection isn’t infinite. If you perform a particular action, your liability protections could be removed, and your assets become vulnerable to legal action.
For example, if an LLC owner commits tax fraud, they will lose their protection. Another example is when you mix your personal and business finances. Since you’re mixing capital from your personal and business accounts, you’re viewed as having a personal involvement in the business’s actions, making you vulnerable.
You also need to be extremely careful about offering guarantees for any loans you take out for your LLC’s business activities. If a lender asks you to provide a personal guarantee, you must consider it seriously.
Personal guarantees mean that you – not the business – are securing the loan. If your LLC can’t keep up with the repayments, your creditors can come after your personal assets.
How to Protect Your LLC from Lawsuits
No business wants to get sued even with your liability protection in place. Litigation is costly and disruptive whether you have an insurance policy in place or not.
The protections you put in place can reduce your chances of being sued and lessen the burden if you find yourself in this situation.
Here are five simple tips for protecting your LLC from lawsuits.
Watch Your Actions
Owners and employees rarely make public announcements or involve themselves in questionable business. Something said in anger could lead to you being sued for slander. Shoddy business practices could lead to you being sued for a conflict of interest.
Think about your integrity and how your actions influence how your business is perceived. For example, if you’re a town council member, you must be extremely careful about how your actions benefit your business.
Make sure you have a firm ethical code and demonstrate those ethics publicly.
Hire an Attorney Now
Most business owners wait until someone sues them to find an attorney. Be proactive, not reactive, by interviewing attorneys right now. Keep them on standby so you can consult them on your business’s actions.
It’s also a good idea to hire a local attorney who knows the rules and regulations about your business in your state and municipality.
Moreover, don’t just look at competent business attorneys. Get the contact details of tax attorneys who can support you if the IRS decides to challenge your tax filings.
Separate Yourself from the Business
The biggest reason why an LLC’s personal liability protections fail is that owners fail to disentangle themselves from their businesses properly. It happens most often when entrepreneurs are so used to operating sole proprietorships that they don’t change how they act when incorporating as an LLC.
Incorporation is the easiest way to separate a business’s assets from your own. Therefore, you should treat it as a separate entity – because that’s what it is. Your LLC should have an independent bank account, and your finances should never become entwined.
If you have significant personal assets, you may even want to invest the money in creating a trust to own the business on your behalf. It’s an extra layer of insulation because trusts are separate legal entities that can sit on the board of an LLC. So if you get sued, it’s the trust that runs the business, not you.
LLCs are the most popular business entity in the U.S. for a reason. The level of protection against the ease and inexpensiveness of incorporation is unparalleled. First, however, you need to know the importance of taking out comprehensive business insurance and what could pierce the corporate veil.
The LLC is not a type of infinite protection. Therefore, creating a business structure that stands the test of time and mitigates your risk of personal liability is crucial.
What type of business structure is best for your company?