I am often asked why someone should form a corporation (Inc) or limited liability company (LLC) for their business. I usually tell them, “Because it is the cheapest insurance policy you can buy!” Why? Once you form an Inc or LLC, you, as the owner(s), are protecting yourself from personal liability for your business-related debts, obligations and liabilities. By forming an Inc or LLC, the government (your state) is now legally recognizing ABC, Inc. as a separate legal entity (a fictional legal person). Your new Inc or LLC can own and sell property, enter into contracts and sue or (hopefully not) be sued. As a result, if ABC, Inc. breaks a contract, ABC, Inc. must be sued rather than you (the owner(s)) personally. This can help protect your personal assets from being subject to any judgments against ABC, Inc.
Of course there are many exceptions to this legal rule (just like ALL legal rules). But if you keep ABC, Inc.’s finances completely separated from your personal dealings (proper accounting, payroll, follow all Inc/LLC legal governing formalities), you can usually keep ABC, Inc.’s “personal liability shield” intact and protect your personal assets.
One big exception that sometimes cannot be avoided is a creditor (or landlord) requiring you (as ABC, Inc.’s owner(s)) to sign a “personal guarantee” for ABC, Inc.’s obligations. This is a device many financial institutions (and savvy landlords) use to get around ABC, Inc.’s liability shield and to help guarantee the obligation will be fulfilled, even if ABC, Inc. goes bankrupt, but you (owner(s)) do not.
Nonetheless, many times you can (and should always try) to negotiate out of a personal guarantee requirement or alter its terms to be more favorable to you. So, as always, make sure you know what you are signing on behalf of your business and always make sure you are not (unless required) signing in your individual capacity, i.e. John Smith, as president of ABC, Inc.
I am here to help if you have business formation questions, contract questions or liability questions. Protect yourself, contact me today!