Why Limited Liability might not be as limited as you think

I am constantly getting questions emailed to me about LLCs, Incs, Ltds etc.
because of the article Legal structures for
bootstrappers I wrote.

One misunderstanding many people have is about limited liability. To understand Limited Liability you first must understand that it was originally introduced to protect the investors and not necessarily the managers of a company.

This basically means that as a stock holder in Microsoft you wont receive a demand for payment of whatever their legal judgments make them pay each month. You can only loose the money you paid for their shares in the first place. Now a large company with thousands of investors is very different from your average one or two man company. First of all you are likely to be the only shareholder(s) as well as officer(s) in the company.

What can you be liable for?

The normal things that a company it self can be liable for are (highly generalized that is):

• Accidents
• Debt

For the accident part you really need some sort of liability insurance if there is some kind of risk involved. This might be something stupid like dropping a printer on the foot of someone at a client site if you are a consultant.

Debt might sound simple, like a business loan or credit card. However you need to remember it also includes things like unpaid bills, unpaid taxes, demands for repayment of fees if your client kicks up a fuss.

Through a company you might be able to skip payment of your unpaid bills and ignore your clients without having to sell your house, but the tax man would more than likely start taking action against the corporate officers. Most
corporate credit cards or loans for small businesses also require the guarantee
of the officers or main share holders. So you really don’t protect your self
all that much.

Officers liability to shareholders

Remember if you are an officer you have a fiduciary duty to your shareholders.
So if you have other shareholders than yourself you can be sued personally for
mismanaging the company. Thus know limited liability.

Liability against partners actions

LTD’s, Inc’s and LLC’s do provide a greater amount of protection against your
partners actions than a regular partnership. This is where there is a clear
benefit.

I stick with my recommendation on using LLC’s for actual moneymaking ventures with more
than one partner. To keep things safe invest the money and register your LLC when you are getting serious.

Limited Liability has nothing to do with Tax planning

Remember to separate tax planning from the other issues such as limited liability, governance etc. For one person operations save the money and hassle
unless there is a real tax advantage in creating an personal holding company
with a Inc. or LTD. LLC’s provide no real tax benefits in this case. A LLC can
easily be structured where each partner has his share through a Inc as well.
This is ideal as each person has different tax requirements.

I will cover the basics of tax planning your business in another post some day,
but simply speaking until you break even there is in most jurisdictions a
distinct benefit in deducting your loss from other income (such as a salary).
When you break even you can incorporate a personal company to hold the profits.
Here you pay an often lower corporate tax and have other benefits.

As long as you save the money up in the company you have a tax benefit. If you
pay some of your profits out in salary and/or dividends you most pay income tax
on this. Thus there really isn’t much of a benefit to the average small
entrepreneur if he needs all of this money to live for. As you can imagine this
is in no way complete information and you should check with accountants on
this. If you can’t afford to pay one you probably aren’t at the point yet where
you need a personal corp.

As always I am not in anyway a lawyer and you should never trust a word I say as I don’t want to have to pay a lawyer myself.