Limiting Liability as a Business Grows

how to limit business liability
Limited liability

When first setting up a small business, your organizational structure is usually pretty simple, something like a sole proprietorship or partnership, where one person owns a company, or two or more people share ownership in the business.

Many small businesses are sole proprietorships, which are the easiest and cheapest to set up. Sole owners have total control of the business and can pretty much do what they want. The owners get all of the income produced by the business. And these kinds of businesses are easy to close down as well. So, it has its advantages.

However, one big disadvantage of a sole proprietorship, according to the Small Business Administration (SBA) is that the owner is completely liable for any debts of the business or actions taken by the business. This also means that the owner’s personal assets are unprotected as well and can be taken.

Partnerships are another common structure for small businesses. They are easy to put together, according to the SBA, and generally cost little money to form. One big disadvantage of a partnership, however, as with a single owner, is the issue of liability. In most partnership arrangements, the owners are fully liable. They are liable for what they do personally, for what their partners do, and for all of their company’s debts. Moreover, the owners’ personal assets are at risk, since they can be used to pay off business debts.

As a business grows, there are different organizational structures that it can adopt to help limit liability. One of these is a corporation. This type of structure is more suitable to a larger business because corporations more often have higher administrative costs and more complicated legal and tax situations.

Legally, a corporation is independent and is owned by its shareholders. But because it is considered legally independent, the corporation itself, not the shareholders, is liable for any debts or other actions. So the assets of the shareholders are protected. The only thing they can lose is their stock in the company.

Another arrangement used to limit exposure to risk is a limited liability company, also known as an LLC. The SBA says an LLC is a combination that gives the legal protection of a corporation and the tax advantages of a partnership.

The owners of an LLC are called members, and the members can be one person, two or more people, or even a corporation. The guidelines vary by state. But the LLC is different from a corporation in that it is not taxed by itself, as a separate organization. Rather, the profits and losses actually go to each member of the LLC, and the members have to report these profits and losses on their personal income tax returns.

But, the SBA states, like a corporation, the members of the LLC are protected from personal liability for business decisions, debt or lawsuits. That is, the members’ personal assets are protected. However, because the structure is a limited liability, there are actions that members are not protected from, such as if they or their employees inflict a financial injury on someone else through some kind of wrongful action.

One of the disadvantages of an LLC is that if one member leaves the company, it has to be closed.

Every organizational structure has its own pros and cons. Be sure to do your due diligence before you decide the right one for your business. Consult with your trusted legal adviser to understand your options.