Let’s take a look at how different business ownership types compare. We will look at the sole proprietorship vs. LLC, LLC vs. corporation, sole proprietorship vs corporation vs. partnership and pros and cons of each. In addition to tax issues, two main items to look at are asset protection and lawsuit protection. Asset protection comes into play when someone sues the owner in a personal lawsuit. How does that type of ownership protect business assets from personal lawsuits? Lawsuit protection is needed when someone sues the business. What happens to the individual owners when an angry customer or supplier sues the business? The quick answer, as you will see, is that the LLC typically provides the best protection from both forms of liability.
Asset protection entails a well-laid plan that is individually crafted for you and your current and future financial needs. There is no one-size-fits-all remedy when it comes to protecting your hard-earned assets. As such, there is no shortage of options today for individuals who wish to protect their assets from predatory claims. The asset protection field continues to expand and diversify, most likely due to the increasingly litigious climate in America. Seasoned asset protection specialists can now offer their clients a range of options to safeguard practically any type of asset.
A business entity is one of the most commonly used asset protection instruments. There are different kinds of business ownership types, such as sole proprietorships, general partnerships, corporations, and limited liability companies. Sole proprietorships and general partnerships are typically the easiest and most cost-effective business entities. However, they offer little by way of effective asset protection. Thus, when someone sues the business, they are by far the most costly.
The corporation is a legally drafted business vehicle. It is set up in such a way that it can continue in perpetuity; that is, unless the existing board dissolves it or by failure to pay the annual renewal fee. The limited liability company, or LLC, is a versatile vehicle that is often a staple in many asset protection plans. An experienced asset protection professional will examine the nature of your business. They will look at the types of assets you wish to protect. Then, they will determine the degree of liability protection for those assets before making recommendations. Give us a call at 1-800-830-1055 to discuss your needs.
Compared to corporations and LLCs, sole proprietorships and general partnerships are typically less costly to set up. As the name suggests, a sole proprietorship is a ‘company’ of one. You and you alone fund the business and make the business decisions. A general partnership involves at least one another person—maybe more. They usually have a financial investment in the business and share in the decision-making process. Both are relatively easy to set up with minimal paperwork. In most states, you don’t even have to register a sole proprietorship with the state government.
However, sole proprietorships and general partnerships offer very little asset protection or lawsuit protection. The U.S. government, for example, does not consider the business activities of a sole proprietorship as an entity separate from the personal assets of the owner. This lack of legal distinction makes seizing assets a lot easier for the judgement creditor. However, it is a bad thing for the legally vulnerable business owner. That is because the creditor can reach both the business assets and the personal assets of the sole proprietor. Getting adequate insurance coverage is one solution. But there are often ceilings on insurance policies, which may not be enough to cover the demands of a covetous plaintiff. Insurance policies without limits are often difficult to obtain. They are also expensive to maintain. Moreover, there are tremendous exceptions written into insurance policies. Insurance companies use these exceptions as loopholes to avoid paying claims.
A general partnership comes with its own set of challenges. In most states, you are co-responsible for the business actions and decisions of your partners. This is true whether or not you agreed to the partner. In fact, you may not even be aware of them. For instance, let’s suppose your partner takes out a business loan without telling you. Even if your partner pockets all of the money, you share in the onus of making sure the loan is paid off in full and on time. As often happens, say the loan is not satisfied. A judgement creditor wins a claim against your business in court. The court, in turn, can permit your creditor to access your business and personal assets to help pay off the loan.
The ease and low cost of setting up a sole proprietorship and a general partnership may be attractive to you as a business owner. But be sure to weigh the advantages and disadvantages of each business type against the amount of asset protection that is offers. You may find the old adage to be true: you get what you pay for—or, in this case, you don’t get what you didn’t pay for; namely, adequate asset protection for your business and personal assets.
A corporation is a separate entity from those who own it. When we look at a sole proprietorship vs. corporation, however, the business and the owner are one in the same in in the sole proprietorship. It is a similar comparison when we look at the partnership vs. corporation. With a partnership, there is not a legal barrier between owners and the individuals.
A corporation is a stock-issuing business entity. Stockholders elect the corporation’s board of directors, who elect officers, who are then authorized to carry out the day-to-day business of the corporation. A corporation’s officers are often comprised of a president, vice-president, secretary, and treasurer. Big corporations typically have a variety of different officials as part of the board of directors. In most jurisdictions one individual can take on the role of a corporate director and hold all other corporate offices at the same time.
Owning stock in a corporation can provide a shield of protection against business lawsuits. Thus, individual creditors may think twice about challenging a corporation in court. Whereas with a sole proprietorship or partnership, a lawsuit against the business equals a lawsuit against the owners as well.
To clarify, there are two sides, business and personal. When someone sues the business, the corporate structure can provide a wall of protection against a shareholder’s personal assets. However, what if the lawsuit is not business-related and a someone sues a shareholder, personally? If a judgement creditor wins a personal lawsuit against an individual who holds shares in a corporation, the creditor can seize any shares owned by that debtor. The creditor can then claim the benefits that come with the shares. If the creditor gains control of more than 50 percent of the shares, he or she can, in effect, control the corporation and the assets it owns.
So, what is the solution? It is possible to get around this liability when someone sues you personally? One solution is to place your shares of stock in the corporation into an asset-protecting instrument. Examples of asset protection instruments are LLCs and trusts. These legal tools can provide strongholds so that judgement-creditors will not have access to the shares. Keep in mind, however, that the law may not allow some of these asset protection instruments to hold shares issued by certain types of corporations (like an S-Corporation). There are tax issues and strict regulations about this kind of set-up as well. For these reasons, you should be extremely careful about using a corporation as an asset protection business entity. Be sure to get expert guidance from a knowledgeable asset protection professional and explore other types of business entities before making a decision.
Like a corporation, an LLC is a business entity that is legally distinct and separate from its owners. This means when someone sues the business, the LLC can protect your personal assets. That is, you do not need to personally pay off the debts and other liabilities that the LLC incurs. Again, when we look at the LLC vs. sole proprietorship, as well as the LLC vs. partnership the separate-entity status of the LLC gives it tremendous advantages. As stated, a lawsuit against the sole proprietorship and partnership exposes the personal assets of the owner. Not so with LLC owners.
Thus, setting up an LLC is a solid small business owner asset protection strategy. Not surprisingly, businesses with significant assets also extensively use LLCs to legally segment one business unit from another. That is, when there is a lawsuit in one business unit, the LLC shields the other units within the parent company. On the other hand, when someone sues the parent company, itself, legal provisions can protect the subsidiary LLCs and the assets therein.
As powerful as this protection is, however, this protection is not absolute. The law may still hold you personally liable for any fraudulent misconduct or wrongdoing you commit in your business transactions. As a rule, however, an LLC has robust and reliable asset protection features.
To maximize these asset protection features, it is important to maintain your LLC as an independent entity. Keep LLC records and finances completely separate from your personal records and finances. Not having this clear line of distinction may be enough to convince a court that the LLC is nothing more than your alter ego. This commingling of assets means the court may permit a judgement creditor to reach into your personal assets to settle a claim against the LLC.
So, for example, don’t pay your personal light bill with LLC money. Pay yourself a salary from your LLC by moving money from your LLC bank account into your personal bank account. Then, pay your light bill from your personal account.
Additionally, whenever possible, avoid personally guaranteeing any loan or liability your LLC takes on. In most states, you are responsible for any debts you personally guarantee for an LLC or any other type of business entity. It can be difficult for your LLC to independently obtain a large loan if your company is just starting out. This is often the reason most business owners personally guarantee loans. However, as soon as it is financially feasible, you should establish a separate line of credit for your LLC. In this way, the LLC alone is responsible for the debts it incurs as a business entity. Creditors cannot touch your personal assets should the LLC prove to be insolvent.
It is also often sound advice to keep just enough money in an LLC to cover its operating expenses and financial obligations. This way, should a creditor win a judgement against the business in court, he or she can access only the small amount in the LLC’s coffers. Keep in mind, however, that if you transfer money or assets out of the LLC after a suit has been filed against it, the court may rule the action as a fraudulent transaction. Alternately, if you don’t keep enough money in the LLC to meet its regular expenses, a court may hold you personally liable for its debts. It may see the LLC’s undercapitalization as a ploy to defraud your business creditors. An LLC has formidable asset protection features. To get the most out of these features, it is often sound advice to seek professional guidance from an expert in the field.
Business entities are often part of a well-crafted asset protection plan. However, this is not always the case. Your particular circumstances may warrant the use of other asset protection instruments, such as trusts, which can be set up domestically or in foreign jurisdictions. Or, your asset protection strategy may involve a combination of different instruments, with each one utilized in a way that best secures your assets. Each business entity comes with pluses and minuses. Call an asset protection professional who can help you maximize each entity’s advantages and find ways to offset its disadvantages.