There are steps you can take as a business owner to limit your exposure and protect your personal assets. This article explains how to legally separate you and your business, thus protecting yourself from the risks of business ownership. By having an entity (corporation or LLC), there is a legal presumption that you are not liable for corporate debts.
If you start a business without forming an entity, then your legal status is “Sole Proprietor.” There is no legal separation between you and your business. The debts and obligations of your business are your personal debts and obligations.
If you do not create an entity but use a business name that is different from your legal name, you need to register a Fictitious Business Name (another article topic altogether). While you are legally required to do this as a sole proprietor, having a registered FBN does not create a separate legal entity, and you remain personally liable for the operations of your business.
Separate Legal Existence
When you create a corporation or LLC that entity has a legal existence that is separate from you personally. The entity is “born” as of the date the Articles of Incorporation (for corporations) or the Articles of Organization (for LLCs) are filed with the Secretary of State.
The general rule is that shareholders, officers and directors of corporations, and members and managers of LLCs, are not liable for the debts or obligations of the company. This is known as the Corporate Shield Doctrine; also known as “limited liability.”
In your contractual dealings with anyone, such as a client, vendor, supplier, contractor, etc., you would clearly designate the full name of your business entity (not your personal name) as the party/signatory to the contract. If you execute the contract on behalf of the entity and not yourself personally, the entity is the proper party to the lawsuit in the event of a dispute. If an adverse judgment is entered, it is against your entity, not you. Your personal assets are protected. If the entity needs to file bankruptcy, your personal credit is left intact (assuming you haven’t personally guaranteed any obligations).
Exceptions to the Rule
As with any general rule, exceptions exist to the Corporate Shield Doctrine. If you fail to pay your employees or commit other Labor Code violations, then you can be personally liable. If you engage in acts outside the scope of your corporate duties, or if you commit fraud, you cannot hide behind your corporation. If you personally guarantee a contract or sign in your personal capacity, then your corporation provides no protection. The most heavily litigated exception is the Alter Ego Doctrine, which is so detailed that it requires a separate article itself. To grossly oversimplify the doctrine, you need to run your company like an actual company; adhere to corporate formalities and maintain separate finances. I’ll dive deeper into that another time.
By creating a corporation or LLC for your business you create a legal separation between you and your company, and the legal presumption is that you are not liable for the obligations of your company. If you are in business, whether you are selling products or performing services, I strongly urge you to consider creating a legal entity to limit your liability and protect your assets.