One of the unique aspects of starting a business in the US is the relative ease with which it can be accomplish. Find some inventory, rent a storefront, turn on your neon sign, and bam! You’re in business.
However, if that’s all you do, you could wind up personally footing the bill for debts of the business. Like any other business decisions, fully understanding the costs and benefits of obtaining limited liability protection will allow you to make an informed decision, and ideally avoid unwelcome surprises down the road. To that end, this article will discuss what “limited liability” means, why it’s important, and how to acquire and maintain it.
What is Limited Liability
A limited liability business entity includes LLCs, corporations, and other entities created under state law. Owners initially obtain limited liability protection by paying a filling fee and filing the necessary paperwork with the secretary of state, and creating the necessary governing documents for the particular entity chosen. For an LLC, this would be the Articles of Organization and Operating Agreement.
The reason many businesses choose a limited liability entity is because the owners of that entity are not liable for the debts of the business itself. For example, if the company takes on a contract dispute, or becomes embroiled in a lawsuit by someone injured in the store, the owners will typically not be personally liable for those debts. If the company cannot satisfy those debts, the entity will be dissolved, and creditors cannot then go after the personal assets of the owners. In other words, the dispute ends at the entity level.
While owners won’t typically be liable for debts of the business, owners are still liable for their individual wrongdoing, as the limitation of liability extends only to the company’s misdeeds. Specifically, if the company breaches a contract it has entered into, the company is the responsible party. When an individual is responsible for some transgression, the company itself may be liable through vicarious liability, but that does not relieve the individual from being personally responsible. In this instance, the wronged party may seek to recover damages first from the entity, but will be entitled to recover from the individual as well if the company cannot satisfy the debt.
How to Maintain Limited Liability
To maintain the liability limitation, owners are required to follow certain “corporate formalities” to prove that a person is not simply using the company as a shell to shield against personal liability. To determine whether an entity has adequately followed these formalities, courts will look at a number of factors, including whether the entity was adequately capitalized or insured. If an entity was not funded, or is undercapitalized from the outset, the court can essentially ignore the entity and attach personal lability to the owners individually.
To recap, limited liability will protect business owners from personal liability where they were not individually responsible for the legal action and where the company followed the necessary formalities. For the majority of business owners, the minimal cost and additional work necessary to established and maintain a limited liability entity are easily justified by the benefits of limited liability.
If you’re thinking about starting a business in or around Portland, Oregon or are interested in learning more about choosing the right business structure, contact us.