Seven Steps to Protect Your LLC
If you own and manage a small business, the odds are high that you chose to set up your business as a limited liability company. In recent years, a majority of all new businesses entities formed in the United States were LLCs. There are obvious reasons, too. A limited liability company provides the same shield against personal liability that a corporation would, but are far more flexible. It provides a pass-through of taxes without the need to follow all the restrictions imposed on S corporations, such as the single class of stock requirement or the prohibition against having other corporations or partnerships as equity owners. An LLC is also easy to set up and, in most states, the state fees are no more expensive than for a corporation.
In fact, the ease of setting up a limited liability company often lures a new business owner into setting up his or her LLC on their own online, or using a service company to file the paperwork for them. Once they have their Articles of Organization, Certificate of Formation or other charter document, they often consider the job finished. They put the papers in a file drawer and get back to running their new business. They assume that they now have all the protections that an LLC can provide.
Unfortunately, things are not really that simple. An LLC provides protection from liabilities only if the LLC is treated as a bona fide entity, separate and apart from its owners. That requires that the members or managers of the LLC follow the formalities that go along with the formation and operation of their new LLC. If they fail to observe those formalities, a court may “pierce the corporate veil” of the LLC and hold the members liable as if there was no limited liability company at all.
What can you do to protect your LLC from the perils of a piercing of the corporate veil? Here are seven simple steps that you can take that will help establish and maintain the separate existence of your LLC:
1. Prepare an Operating Agreement that fully and accurately reflects the terms of the agreement between you and any other members. Even if you are the only member and the only manager, it makes sense to adopt a simple and straightforward Operating Agreement that reflects that the actions you are taking are within the scope of your rights and duties as a member and/or manager.
2. Set up a separate bank account and make sure that all funds of the company are put into and drawn out of that account. Commingling your personal funds with the funds of the business is a sure way of exposing yourself to potential liabilities of the business. After all, if you don’t draw a distinction between what is yours and what belongs to the business, how can you expect a court to honor those lines?
3. Carefully document all transactions with third parties. Clearly indicate that the business transaction is with the LLC. Always sign documents in the name of the LLC, as member or manager, as appropriate. Signing as “Jane Smith” rather than as “Jane Smith, manager” can lead to personal liability.
4. Reflect major transactions in the official records of the company. Although the LLC statutes do not require that LLCs hold annual meetings and formally keep minutes, some courts have pointed to the failure to do so as an indication that the members are disregarding the entity. Be safe. If you have more than one member, you will probably hold meetings from time to time. Document them with appropriate minutes. Even if you have a single member LLC, record your approval of significant acts as actions you are taking in your role as member or manager.
5. When you start your business, make sure the LLC has enough capital to pay its foreseeable debts and expenses. If the LLC is undercapitalized from its beginning, it is much more likely that a court will look through the entity to your personal assets.
6. Act prudently in your business. If you incur debts which the LLC clearly is going to be unable to pay, the creditor is going to have a much easier time seeking payment out of your personal assets.
7. Finally, carry adequate insurance. While the LLC provides a great deal of protection from trade debt and contractual obligations, liabilities for injuries to third parties are often a different story. In most small business, if the business was negligent, then very likely the owner was also personally negligent. The fact that an injured party may not be able to recover damages from you attributable to the business’ negligence does not prevent that person from collecting for your own negligence.
While there is no guarantee that the LLC will protect your personal assets from every possible claim arising out of the business, following these seven steps will help strengthen the statutory protection that has led you to choose a limited liability company as your form of business. A small business lawyer can help you by reviewing your documents and procedures and recommending specific steps to preserve the protections of your LLC.