When you’re about to start your own business, one of the most important considerations to make is how you should structure it in order to protect your personal assets. Without this protection, your business could be sued or face bankruptcy and you would stand to lose your personal property as a result. Here’s what you need to know about asset protection as a small business owner.
Why a Sole Proprietorship Isn’t a Good Idea
If you’re starting a small business or you’ve had a hobby evolve into a side income, you may think operating as a sole proprietorship is your best option. While this may certainly be the easiest way to start a business, it’s not the best by any means—a sole proprietorship essentially means that you are your business and your business is you. In other words, business creditors can go after your personal assets to pay debts, not just your business assets, putting you and your family at risk.
Even if you believe your business is too small to end up in such a situation, this protection is necessary. Your business name may infringe on someone else’s trademark, a photo you share on Facebook might violate copyright law, a client may sue you for breach of contract if they’re not happy with your work. It’s simply not a risk worth taking.
Incorporating Your Business vs. Forming a Limited Liability Company
How do you protect your personal assets when you own your own business? It’s simple: by incorporating it or by forming an LLC.
Registering as a C Corporation
Of the two options, incorporating a business is more involved. A skilled business attorney can assist you with the process, which begins by filing a Certificate of Incorporation with the State of Texas. By incorporating your business, you are ensuring that it is completely separate from you as a person; your business’s assets and liabilities are separate from your personal assets and liabilities. If there is a court ruling against your business or if your business falls into debt, you are not personally responsible.
Registering as a C Corporation requires you to comply with a number of rules, not only when you first apply to incorporate, but also in the future. You’ll need to ensure that your business files annual reports and makes financial disclosures; you’ll also need a board of directors, regular meetings with these directors, and corporate bylaws. If you fail to meet these obligations, you can be fined or even have your business dissolved—and if your business is dissolved, you lose the protection of your personal assets.
Forming an LLC
Most small business owners opt to form an LLC instead of registering as a C corporation because it protects their personal assets without all of the ongoing legal obligations required of corporations.
While an LLC doesn’t offer the same level of protection as a corporation, in most cases creditors can only seize business assets from an LLC. There is a scenario called “piercing the corporate veil” in which a court determines that your personal finances and your LLC’s finances were commingled, and therefore you can be held personally responsible for your business debts. You might also still have liability with an LLC if you personally guarantee a business loan or take other actions that blur the boundaries between personal and business.
Deciding on the Best Asset Protection Strategy
Is an LLC right for your business? Or should you incorporate instead? The best way to find out is to consult with a business attorney. We’ll go over your assets, examine your business operations, and assess your risk in order to determine the best way to protect your personal assets.