Some types of business entities--corporations and limited liability companies are the most common--shield their owners from personal responsibility for business debts. That is, if the business goes bankrupt, its owners are not usually required to use their personal assets to make good on business losses--unless they voluntarily assume responsibility. Other types of business--sole proprietorships and general partnerships--do not provide this shield, which means their owners are personally responsible for business liabilities. To see how this works, assume a large court judgment is obtained against an incorporated business. Because corporate stockholders and LLC members are not personally liable for business debts, their houses and other assets can't be grabbed even if the corporation or LLC files for bankruptcy. By comparison, if a sole proprietorship or general partnership gets into the same kind of trouble, the houses, bank accounts and other valuable personal assets of the business' owners can be attached to satisfy the debt.

Achieving limited liability status is extremely valuable for businesses that may be vulnerable to lawsuits, or ones that have run up significant debts. However, some small businesses simply don't have major debt or lawsuit worries, so they don't need limited liability protection. For example, if you run a small service business (perhaps you are a graphic artist, management consultant or music teacher), your chances of being sued or running up big debts are low. And when it comes to liability for many types of debts, achieving limited liability status makes little practical difference for newly-created businesses: If you want to borrow money to fund a start-up or establish credit with a new vendor, you will probably be required to pledge your personal assets (waive limited liability status), so you'll be on the hook should your business be unable to pay.

Finally, even if your business faces serious and predictable risks (say, the risk that a customer may trip and fall on your premises or that your products may malfunction), organizing your business to achieve limited liability status is no substitute for purchasing a good insurance policy. After all, without a decent insurance policy, if a serious injury occurs, all the assets of your business--which will probably amount to a large portion of your net worth--can be grabbed to satisfy any resulting court judgment. It follows that if you purchase comprehensive business insurance, your personal assets are not at significant risk and you may therefore sensibly conclude you don't need limited liability status.

Protect Yourself and Your Businesses by Defining Risks

Start with a list of the aspects of your business where legal trouble is likely. Every business faces potential legal hassles regarding taxes, hiring and firing employees, and collecting overdue accounts.

Add to this list your particular concerns. Consider carefully what your potential liabilities are if someone is injured or suffers an economic loss if your product is defective or your service substandard. For example, suppose you operate a copy shop in leased premises with ten employees. You have a heavy walk-in trade, and you also make deliveries to important customers. Potential legal risks of your business include:

  • customers being hurt on your premises;
  • a delivery vehicle accident;
  • the possibility that an employee may lose or damage a customer's original documents;
  • storage and disposal of toxic chemicals;
  • problems with your lease, and if it ends soon, the legal and practical aspects of renewing it; and
  • the possibility that an employee will quit and open up a similar business across the street, having stolen your confidential customer list.

Copyright 1999, Inc.