LLC Protection Explained: What Does an LLC Protect You From?

Delina Chantel Yasmeh
Published by Delina Chantel Yasmeh | Author
Last updated: June 19, 2024
FACT CHECKED by Lou Viveros, Growth & Transition Advisor
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A Limited Liability Company (LCC) serves as a protective barrier for business owners, safeguarding personal assets from the reach of business debts and legal claims.

This structure is pivotal in ensuring that private properties like homes and vehicles are not seized to settle business liabilities.

As a lawyer specializing in high-stakes transactions, I've navigated the complexities of starting an LLC as well as investigated LLC protections, ensuring that personal assets remain secure against unforeseen business challenges.

My expertise in this field underscores the importance of meticulous legal structuring and strategic planning in leveraging the full protective capabilities of an LLC.

Join me as we explore the critical considerations every business owner must understand to truly safeguard their assets.

Quick Summary

  • Forming an LLC provides protection for personal assets against certain business debts and claims, ensuring members' personal property remains unaffected by business liabilities.
  • LLCs offer a shield for personal assets from business-related lawsuits, but this protection varies by state law and the nature of the claim.
  • A significant statistic to consider is that 20.8% of private sector businesses in the U.S. fail within the first year, emphasizing the importance of LLCs for personal liability protection.
  • From my perspective, the protection offered by an LLC is a crucial consideration for entrepreneurs, as it allows for risk-taking in business without jeopardizing personal financial security.


What Type of Liability Protection Do You Get with an LLC?

A woman choosing a type of liability protection for an LLC

The type of liability protection you can get with an LLC is protection of your personal assets if the business fails or gets sued.

According to a 2018 report from the National Small Business Association, 35% of small businesses were LLCs and 12% were sole proprietorships in 2017, indicating a significant preference for the LLC structure [1].

An LLC protects its owners, known as members, against personal liability for certain debts and claims against the business. Personal liability protection involves the personal assets protected in the event of default, bankruptcy, or other claims against a business.

This means that if you leave behind unpaid credit card debt when you dissolve the business, your personal credit is not typically affected.

However, limited liability companies do not automatically bestow personal liability protection on you.

LLC owners' liability protection depends on state law and the type of claim being asserted against the business.

In addition, personal assets may still be vulnerable if you fail to form an LLC properly or maintain adequate insurance coverage.

Personal liability is a concern when people operate a business without establishing a separate legal entity to protect their assets, such as a corporation or a limited liability company.

Personal liability means that creditors of the business may take the owners' funds and possessions to satisfy outstanding business debts.

Is the Owner of an LLC Personally Liable?

Whether the owner of an LLC is liable depends on the state. Most states treat the LLC owner as not personally responsible for any wrongdoing their employees or co-owners do.

This means no personal assets would be used to cover any business-related debts, including lawsuits pursued by customers or vendors, fines issued by state regulators, etc.

Some states are more concerned with the lawsuit protection of LLC members from personal liability than others.

Texas protects members from personal liability better than most other states. If you are concerned about this for your business, you should consult with a member of your team who has experience with LLCs in your state.

A knowledgeable source will provide the proper guidance for assembling your LLC and understanding your legal obligations.

In most cases, members of an LLC are not personally liable. Some exceptions exist for specific situations, such as when a member is responsible for reporting or paying withholding taxes.

Even in these cases, the legal burden of proof is typically very high.

Are LLC Owners Responsible for LLC Debts?

A discussion between two people about a certain file

In general, LLC owners are not responsible for the debts of the LLC unless they guarantee the debt or make another agreement to be held personally liable.

According to an article published by Ohio State University, an LLC owner can be held personally liable in various instances, including when an LLC member signs a personal guarantee, pays taxes as an LLC instead of an LLC entity, or makes a personal promise to creditors [2].

Considering that 20.8% of private sector businesses in the U.S. fail within the first year and, after five years, 48.4% have faltered, as per the U.S. Bureau of Labor Statistics, protection against personal liability becomes a crucial factor for business owners [3].

"While it is typically understood that LLC members or owners are not personally responsible for the LLC's debts, there are exceptions where they might be held accountable: if they provide a personal guarantee for the debt, or if, under rare conditions, a court opts to 'pierce the corporate veil' and assign personal liability to them."

- Jon Morgan, Co-Founder & Chief Editor of Venture Smarter

When LLC members sign a personal guarantee, they promise to pay the LLC's debts if the LLC does not.

I often advise LLC members to understand the implications of personal guarantees and explore negotiation possibilities to limit personal risk, as ignorance of the terms can lead to unintended personal financial responsibility.

These guarantees can be written into an LLC operating agreement or in separate contracts between the LLC owner and creditor.

Your LLC’s Liability for Members’ Personal Debts

If you own an LLC with others, the company must be protected from personal bank accounts because certain debts are confidential for everyone involved.

This protection is not absolute but can offer business owners significant peace of mind. One way to protect the business from personal debts is to separate the business' bank account from anyone else who is a member.

Although an LLC member's personal bank account should not be directly connected to the business account, members can still deposit private funds into company accounts.

A creditor might try to go after joint accounts owned by all the members, including personal bank accounts, because it can access money in those other accounts under certain circumstances.

Iharshal of ProfitBooks recommends classifying business and personal finances and opening separate expense and bank accounts to separate your personal and business assets [4].

This way, if a creditor goes after a joint account, you won't lose the money in the business and personal accounts.

Case Study: A Client From Austin

Founded in 2017 in Austin, Texas, a startup I worked with developed cybersecurity software. However, in 2019, the startup faced a major financial hurdle. A critical software launch failed to meet expected standards, leading to client dissatisfaction and contract cancellations.

This resulted in substantial revenue losses, leaving the company unable to meet its debt obligations. Creditors began pursuing recovery of the owed amounts, totaling approximately $500,000.

Fortunately, the company was structured as an LLC, which played a crucial role in shielding the personal assets of its owners during this financial crisis.

The company underwent a structured settlement with its creditors, negotiated by their legal team, allowing the company to pay off its debts over an extended period without affecting the personal financial security of its owners. This arrangement provided them with the breathing room needed to restructure and refocus their business strategy.

FAQs

Does an LLC Always Protect Your Personal Assets?

An LLC will typically protect the personal assets of its members, but not always.

If you plan to open an LLC to protect your assets, you must seek legal advice. The laws surrounding LLCs vary from state to state, so working with a lawyer who knows the rules and regulations for creating and administering an LLC in your state is essential.

What Does an LLC Not Protect You From?

An LLC does not protect you from wrongful termination lawsuits or similar employment claims. LLCs do not protect their members from their own negligence or personal wrongdoing. Also, you can still be sued for damages related to your business activities and may be held liable for the debt of an LLC if you guarantee it.

Does Forming an LLC Protect Personal Assets From the Actions of Other Members?

Forming an LLC protects personal assets from the actions of other members. However, this protection is not extended to private funds commingled with business funds, which could undermine the separation between personal and business finances.

References:

  1. https://www.nsba.biz/
  2. https://farmoffice.osu.edu/blog-tags/llc-personal-guaranty
  3. https://www.bls.gov/bdm/us_age_naics_00_table7.txt
  4. https://profitbooks.net/how-to-separate-your-business-and-personal-finances/

 

About The Author

Author
Delina Chantel Yasmeh, J.D./Tax LL.M, specializes in Mergers and Acquisitions at Deloitte and PwC, managing billion-dollar transactions. Educated in Accountancy at California State University and holding advanced degrees from Loyola Law School, she is highly skilled in tax law. Delina also dedicates time to pro bono work for women and children.
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Growth & Transition Advisor
LJ Viveros has 40 years of experience in founding and scaling businesses, including a significant sale to Logitech. He has led Market Solutions LLC since 1999, focusing on strategic transitions for global brands. A graduate of Saint Mary’s College in Communications, LJ is also a distinguished Matsushita Executive alumnus.
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