In previous posts, I explained the different types of entities available to individuals who want to start (or improve) their businesses. As explained before, probably 99% of small and mid-sized businesses operate as one of five basic business entities:
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Company
- Corporation (an “Inc.”)
Today, we will compare two of those common business entities.
The Sole Proprietorships Versus The Limited Liability Company
As a sole proprietor (also known as a “DBA”), you are personally liable for all monetary obligations that you incur, including things such as business debts and/or legal judgments against your business. For example, if you breach a business contract or fail to repay a business loan, your personal assets are at risk—regardless of whether the contract/loan was related to your business. In addition, if an employee happens to win a judgment against the business for things such as wrongful termination, etc., the employee’s lawyer can go after your personal assets, which includes personal property such as bank accounts, and (in some instances) your homes and/or cars. Some businesses—especially some that are just starting out—don’t mind being exposed to unlimited personal liability. But for the vast majority of businesses, the liability protections provided by a Limited Liability Company (“LLC”) are invaluable.
By doing business through a properly formed LLC, you can greatly reduce the above-described risks. For liability purposes, the law treats an LLC as separate and distinct entity from the owners. In an LLC, an owner is called a member. For the most part, an owner may only lose what he or she invested in the LLC. Except where a personal guarantee is involved, an owner normally isn’t liable for the contracts and/or loans made to the LLC. This means a creditor or judgment-holder can’t seize an owner’s personal assets. So let’s return to the earlier example, but with an important variation. Suppose you form an LLC rather than simply registering your sole proprietorship as a “DBA.” This time, if the employee wins a $100,000 verdict, you generally won’t be personally liable for paying the money (assuming you weren’t the one that committed the act). Be aware, however, an LLC doesn’t give you a 100% safety net. You can still face personal liability if you’re the person who intentionally causes harm to someone—such as sexual harassment or intentionally injuring a customer. That’s also true if you personally guarantee a business obligation like a bank loan.
Making Your Choice
In most cases, the LLC has a huge advantage over a simple sole proprietorship “DBA.” An LLC is fairly simple to form, and it gives you maximum flexibility in how you structure your business while offering important personal liability protection. If you’re already set up as an LLC, it is probably best to stick with it. If, however, you’re just starting out or you’ve already formed a sole proprietorship or general partnership, now is a good time to think about whether to convert to an LLC.