Using a business entity to limit personal liability.One of the greatest blessings of living in the United States is the freedom we enjoy. We are free to exercise our religion, speak our minds, own firearms, retain privacy, and so much more. We have the freedom to pursue the American Dream and create successful businesses, and many people do!
Recent U.S. Small Business Administration data shows that there are over 30.2 million small businesses in the United States. These small businesses encapsulate the blood, sweat, and tears of many Americans and illustrate the great opportunities for success available to all. However, the freedom to succeed also brings with it the freedom to fail.
As you are considering starting your business or have transitioned into the beginning stages of running your business, it is important to understand the probability of success as well as how to avoid the liability that leads to failure. Recent U.S. Bureau of Labor Statistics data shows about 20 percent of small businesses fail within their first year. Within five years, nearly 50 percent of small businesses fail. Only about 35 percent of small businesses survive past the 10-year mark. It is critical to understand the basics of personal liability to ensure that your business remains in the third that succeed long-term.
This month I was approached by an individual (whom I will call Sarah) who was interested in forming a Limited Liability Company (LLC). Sarah had been running her business as a sole proprietorship and was referred by another business owner that had suggested she form an LLC. During our conversation, Sarah explained that she was not familiar with business structure, liability protection, or taxing options. This conversation reminded me that many entrepreneurs may not have access to or understanding of this information.
Here are two important tips to keep in mind when starting and running a small business:
Choose a business structure that limits your personal liability. Putting your shingle out and running your business as a sole proprietor means that you are personally liable if someone sues you. This means that you could lose your home, vehicles, bank accounts, and other personal property in addition to your business property. Forming an LLC would limit your personal liability and only expose business assets in a lawsuit.
Make sure you do not commingle funds. You may lose the protections of your chosen business structure if you pierce the corporate veil. One of the most common ways small business owners pierce the corporate veil is by commingling funds, meaning you use business funds for personal use. For example, I have a client who used to pay for his mortgage, insurance, groceries, etc. with his business account because that was where the money was. It took a lot of discipline to break those habits and separate business and personal expenses.
Being conscientious of limiting your personal liability takes practice and discipline, but the effort is well worth the cost avoidance. We have great business entity services at Intervivos that we can combine with a trust to further minimize personal liability.