Limiting Losses Legally

Transcript

ELIOT WAGONHEIM: You do not have to have an "Inc." after your name and you do not have to have an "LLC" or "limited partnership" after your name -- just could be your own name. You could go out there, you could sell whatever you want to sell or render whatever services. Millions of people do it, there is no law against it.

EDWARD HILLER: You are the sole proprietor, you are the sole proprietorship. There is really no distinction between yourself and your business.

WAGONHEIM: If something goes wrong, the person who is running the business is personally liable. John Smith's house is on the line, his car, his Honus Wagner baseball card, everything that he owns is on the line.

HILLER: So if you default on the contract, you injure somebody and do not have proper protection, your personal assets are all at risk.

FRED PROVORNY: One way to avoid that is using either a limited liability company or corporation.

HILLER: A corporation or an LLC is treated as a separate "person," if you will.

WAGONHEIM: Let us form something that actually is the business and so if something goes wrong, that entity, that LLC or that corporation is what is on the line.

PROVORNY: Creditors then cannot go after your personal assets.

WAGONHEIM: It is the corporation that will be sued or the LLC that will be named in the lawsuit. And so John Smith and his Honus Wagner baseball card and his car and his house are not at risk.

EDWARD JACOBSON: I have seen a problem when people create an entity like an LLC and it is set up in name, but all the expenses are running through a personal checkbook.

People will often take business payments and deposit them directly into their personal account.

JACOBSON: Somebody coming in could challenge that this LLC is a sham, it is a shell.

HILLER: It is just the corporation in name only, you are really operating it as an individual, therefore we are going to come after your individual assets.

JACOBSON: That is a potential problem.

File Notes

The need for legal protection begins at the birth of a business and continues throughout the life of all companies.  When creating a new business, or exploring options in reorganizing existing companies, businesses must understand their legal options for minimizing liability.  Among those options are the proprietorship, partnership, corporation and limited liability company.

THE NOT-SO-TRIVIA QUESTION:
Which of These Companies Limit the Liability of their Owners?

Sole Proprietorships?

NOPE.

The "sole proprietorship" is generally a one-person operation where the profits, losses and liability flow to the individual. Without formal legal protections provided through the corporate form and limited liability companies, an investor may lose much more than his own investment in the business. In fact, in the event of serious losses and liabilities, all of the individual investor's assets may be subject to the claims of business creditors -- far beyond the assets of the business.

Partnerships?

NOPE, at least not if you're a general partner. And you get the added bonus of being liable for your partner's screw-ups too!

Partnerships may be "general" or "limited". A general partnership is one in which two or more individuals own a portion of the business assets directly and are all liable individually for the partnership debts. A limited partnership has two classes of partners, general and limited. The general partners manage the partnership with exposure for the liabilities of the business. The limited partners are usually shielded from liability for business debts beyond their investment in the business as long as they are not involved in the management of the business.

Corporations?

YUP, now we're getting somewhere!

A corporation generally provides a shield from individual liability as long as corporate and individual assets are kept separate. While the "corporate veil" of protection is very helpful in protecting its shareholders from personal liability for major debts and losses, the process of incorporating a business invites a host of income tax options which may affect the precise form of each company and the financial stability of its owners.

Limited Liability Companies?

BINGO!

This is a newcomer to the world of limited liability companies. LLCs operate with the seeming simplicity of partnerships, but with the asset protection of corporations. The members of the "LLC" operate the company under the terms of an operating agreement that sets forth the method by which the company shall be managed on a daily basis and in exceptional transactions. This important agreement also provides for the transfer of ownership rights in the business and many other important events in the life of a company.

With so many options, and major consequences for those making the wrong choice, an experienced business attorney is essential to the business formation and organization process.