Is Forming an LLC Worth It? What an LLC Really Does
Many new business owners see creating an LLC as a sign of being an official business or that they’ve joined the big leagues. While LLCs do have benefits, they may not be everything people think they are. Here are some of the most important limitations and where LLCs still help.
Liability Protection Might Not Apply to Personal Acts
LLCs provide a broad array of protections against losing personal assets due to business debts, lawsuits, or other losses. However, these protections are not absolute.
One of the biggest holes is for services performed personally by the LLC owner. If the LLC owner commits an act of negligence, even when working for the LLC, the owner may still have some personal liability. (By contrast, the owner usually wouldn’t be personally liable for a similar act of negligence by an employee).
In short, an LLC mainly protects against debts and losses caused by the actions of others. If you need protection for your own actions, you’ll likely need liability insurance rather than relying on the LLC.
Lenders Can Ignore Your LLC
Your LLC only protects you from personal liability for business debts if the lender agrees to do business with the LLC. Most small business loan contracts have a clause that requires you to take personal liability for any business debts.
Once you sign the contract, it’s as if you co-signed for someone’s car loan. The LLC will make payments first, but if it runs out of money, you’ll need to pay from your personal assets.
If you don’t agree to this, you may find it impossible to get a loan. Most lenders won’t lend to an LLC without the owner’s personal backing unless the LLC has a lengthy history of positive cash flows.
Your LLC May Not Carry to Other States
LLCs are a state law creation so are recognized on a state-by-state basis. If you do business across state lines, you may need to register in each state where you do business.
If you don’t meet a specific state’s requirements, your LLC may not protect you against any debts or lawsuits arising out of your activities in that state. Further, doing business in other states as an LLC could subject you to additional taxes and state filing fees that you might not face as a sole proprietor, so it could lessen the benefit of an LLC.
None of this means that you shouldn’t form an LLC as it may still be right for your business. But you should talk to your legal and tax advisers to make sure an LLC will do what you’re expecting it to do.