New business owners should think twice before using an LLC. Most people think you need to have a legal entity set up in order to operate a business. That is simply not true! I have many clients who operate successful small businesses without using a legal entity. This form of business is known as a “sole proprietor.”
A sole proprietor is one individual owning and running a business. There is no legal distinction between the business and the individual owner. There is no legal shield to protect the owner’s personal assets. The individual is personally liable for the legal and financial obligations of the business. This is what leads most business owners to use the protection of an LLC, so, let’s explore this issue further.
Personal Guarantees
Many people set up an LLC before even starting to operate their business. This can cost several hundred dollars and creates an annual state filing requirement. As their business grows, they may decide to lease office space or finance equipment. At this point, they are surprised when they are required to sign a PERSONAL guarantee even when they have an LLC! This personal guarantee means that the business owner is personally liable for the lease or loan payments. The truth is, an LLC does not always mean you avoid personal liability for the debts of your business. This is one reason why you should think twice about using an LLC.
Negligence and Malpractice
Small business owners also worry about legal liability if a customer decides to sue them. It is important to know that an LLC will not protect you against personal liability for negligence, malpractice, or other personal wrongdoing that YOU commit related to your business. One way to mitigate this risk is to purchase professional liability insurance. Depending on your industry, it is a fairly affordable insurance product. It is also something you should carry whether or not you’re a sole proprietor. Additionally, if you will have an office or physical storefront with frequent customer traffic, you should carry general liability insurance. This will protect you if a customer gets injured while they are at your place of business. You are able to protect yourself without an LLC by carrying appropriate insurance for your business. This is another reason why you should think twice about using an LLC.
When an LLC is recommended
I will admit that there are times when using an LLC is a good decision. For example, high net worth individuals are best protected by an LLC. In most states your home and retirement accounts are protected from creditors under specific laws. Each state’s rules are different, so it is best to research the protection your state laws provide. Individuals with significant assets or wealth that is NOT protected from creditors by specific state laws will want to use an LLC to operate a business.
Additionally, if you hire employees or take on a business partner, you will want to use an LLC. The LLC will protect you from personal liability for negligent actions or malpractice by LLC co-owners or employees. It will also protect you from other legal claims as long as your own negligence, malpractice or other personal wrongdoing are not a factor in the claim.
My Approach
I encourage most of my small business clients to start out as sole proprietors with appropriate insurance coverage, as long as their attorney agrees. Oftentimes, there is no need to use an LLC right from the start. As their business grows and changes, they can open an LLC at any time. If you want your small business to seem like a more formal business entity, in most states you can register a Doing Business As (commonly known as a DBA) certificate with your County Clerk’s office for a nominal fee. This DBA gives you a formal name for your business that you can use in advertising and on business cards.
Some of my clients who operate their businesses as sole proprietors include: a personal trainer, a hair stylist, a window installer, an interior designer, a web designer, a pet sitter and a massage therapist. These business owners do not have a retail location, employees or business partners. Their personal liability can be limited through appropriate insurance. Some of my clients who operate their businesses in an LLC include: a retail bakery, a gym owner, a chiropractor, a restaurant owner, a children’s dance studio and a wine distributor. These businesses all have a physical retail location and/or a number of employees. Therefore, it makes sense to use an LLC to protect them from various types of legal claims that could arise. Additionally, several of them are high net worth individuals with substantial personal assets that we want to protect from outside creditors.
Disclaimer
I am not an attorney and am not providing legal advice. My best advice is to consider the factors I have presented and consult with your attorney before forming a separate legal entity to operate your small business. Also, you can read this article by an attorney on Legal Zoom for another opinion: Do I need an LLC to start a business? | LegalZoom