Updated: Aug 6
For starters, let's be clear!
In no conceivable way, am I knocking sole-proprietorships ("SP").
That's not what this is about.
For a lot of people- a SP makes sense. But they do have their short-comings, particularly, when it comes to liability.
So with this in mind, please do not take this blog personal, if say, you're a gun-toting SP person.
Lawsuits: Should you worry?
LISTEN! IF your business is completely off-grid, and you don't expose yourself to the outside world, like at all,...then you probably don't have to worry about ever being SUED.
BUT chances are-- that's not your business, and it never will be.
What's my ANGLE HERE!!?:
I know you're probably thinking...."You're an attorney that gets paid to form LLCs, so ipso facto, this is just a marketing scheme for you to drum-up more business, right?!"
Look--I like this whole incorporation thing, but I don't LOVE IT. Frankly, I much rather write fiction. But that's a conversation for another day. My objective here, is yes...to drum-up some business, but also, to give you some USEFUL INFORMATION along the way; so that when we're all done here, you might be able to make an informed decision as to whether a SP or LLC is right for you.
...SO enough of the rah-rah--lets get down to business.
How do SP and LLCs really stack up to one another, when things aren't all, let's say, "Sunshine and Roses!?"
When-- for a lack of a better word, "THE Shit hits the Fan!?
Pros and Cons of the two (2) Business Structures:
low start-up cost
no additional taxes
business account and checks
can use your SSN (no need for EIN)
no separation between you and the business
harder to raise capital (loans, investors)
personally liable for business debts
not as reputable in the public's eyes
harder to expand
Limited Liability Company
Personal Liability Protection
Separation between you and the business
Easier to raise capital (business loans, investors)
Reputable in the eyes of the public
easier to expand
more government oversight and taxes
more paperwork to be filed with the state
more start-up costs
SP v. LLC:
How one makes SENSE, the other,--a Ticking TIME BOMB!!!
[If you never want to expand, or just like living on the EDGE, please disregard the following]
To best illustrate the comparison between SP and LLC lets look at an EXAMPLE.
(These are always fun).
HARRY MILES, a happy-go-lucky man in his early thirties, with a full-set of hair, and dreamy brown eyes, decides to one day start a GLASS BUSINESS! Not too far-fetched, considering his dad did it, and so did his dad before him.
Alright, so we have the basic premise here,,
- Lets continue.
Harry the cash strapped entrepreneur he is, decides to register with the local county as a SP. He gets the Fictitious Business Name; even gets a few business cards made. Things are looking good for old Harry (just a figure of speech, Harry's really not that old).
By the end of the week, Harry is a bona fide SP, doing business as, "I LOVE GLASS." Needless to say, he is ecstatic! But the honeymoon doesn't last long. A bit of marketing and some referrals, and suddenly Harry is off to the races; expanding his business and even taking jobs outside the county.
So what's the problem you say? After all from where I'm standing things are looking pretty good.
In the HOOPLA of long hours and sleepless nights, Harry made a very human mistake. One that unfortunately resulted in an injury, to the tune of $300,000.
Once teeming with excitement, Harry now finds himself the SUBJECT of a $300,000 personal injury lawsuit. WHoah.--
-How's that for having the tables turned on you.
Licensed, bonded, and insured:
This word trio is so commonly thrown around, that its practically a cliche.
But what does: licensed, bonded, and insured, mean exactly?--
To answer this, let' weave it into our story...
Let's assume Harry is licensed. Great, so does that help him when it comes to a personal injury lawsuit?
Licensed or not, Harry installed the glass; the glass did something it wasn't supposed to do; and as a result, someone was injured.
Hence, license or not, Harry is liable.
But hold on RJM, what about his bond?--
Surely that means something?
Any good contractor will tell you that if they never have to reimburse another surety bond, that's still too soon!
Look, a bond doesn't protect you, it protects third-party consumers and the public. Put another way, it protects against your faulty work.
THUS, when it comes to personal liability, a bond, contrary to its name, is not going to BAIL you out.
Well...how about insurance?-- I mean, that's the whole point, right? Something bad happens, insurance saves your a$$? Well...maybe, and it depends.....famous last words.
Look- insurance is great when it's ENOUGH to cover the costs.
But when its not- it's nothing more than a deduction, and sometimes, not even a good one.
So in this hypothetical let's give Harry a $50,000 per injury and a $100,000 per year insurance policy. Therefore, Harry is covered up to $100k per year, but only $50k per incident. Make sense?- Good. Okay...so fortunately for me (I'm not a mathematician by any stretch of the word) the math is easy. $300k (Hospital Bills/Liability) minus $50K (insurance policy) equals $250k.
The Two-hundred thousand dollar figure represents Harry's BALANCE after the insurance deduction. Or put more ominously, Harry's PERSONAL LIABILITY. Doesn't matter that Harry's work, and the subsequent injury, happened under the guise of, "I Love Glass."
BECAUSE in the state's eyes (and thus the court's eyes), "Harry Miles and I LOVE GLASS" are exactly the same person, entity, or thing.
In other words, there is no fundamental difference between Harry and his business.
For liability purposes, they are one and the same! Which in-turn means, if we're going to be blunt here....that everything I Love Glass is liable for, so is Harry. Personal assets and all!
When it Rains, it Pours!
In one month, Harry's business went from climbing the PROVERBIAL MOUNT EVEREST, to the existential equivalent of HELL ON EARTH.
Just like that, Harry's dreams are crushed.
One itty-bitty change goes a long way:
What if we made one little, yet mighty change to this story.
Instead of a SP, what if Harry formed an LLC.
SAME facts as above, but this time with an "I Love Glass, LLC"
So how much does Harry owe in this scenario?
-To answer this, we'll need to analyze some key facts.
Like what the LLC owns versus what Harry owns:
The LLC owns a truck, has some cash
reserves, and a bank account.
All in all- I Love Glass has assets totaling $50k.
Harry's Personal Assets:
Harry has substantial assets, including a
home, personal vehicle, personal bank
accounts, etc.. totaling in at $500k.
So now for the big question! How does this all fit in for liability purposes? And how does Harry's Personal Assets fare in light of I Love Glass, LLC?
Half of it, a 1/3rd, 10%....?
What if I told you with a straight face that not a single one of Harry's personal assets would be taken. That everything outside of what the LLC owns is safe. Would you believe me? You should.
Now your head is really spinning, right? Kind of like Linda Blair in the Exorcist? Yeah, mind was too.
Listen. As an LLC Member or Manager you are not personally liable for the claims brought against the LLC. Nor is your personal property. I mean that's WHY people, even individuals, opt-out of a SP, and opt-into an LLC.
For liability purposes, it just makes sense!
SP simply do not have anything comparable. If someone comes after your business, and you are set up as a SP, I'm sorry...but you and everything you own is subject to a personal injury lawsuit.
There's really no two ways about it.
LETS pause for a second because I can already hear people yelling at their computer screen...,"That's absurd!!!" and "How can a company just get away with this!?" And so on and so forth.... Look I get it, but that's just the reality of corporations and LLCs. On the flip side, neither would likely exist without these safeguards.
Can you imagine CEOs of giant corporation being stripped of everything they own in the face of one gargantuan lawsuit!!
BUT before anyone gets the wrong idea, the LLC isn't getting off scot-free in our hypo. It's going to pay, and may even have to file for bankruptcy.
But, that's where the Proverbial Buck Stops! GOING BACK to our example for a second, If the LLC owns $50k in assets, and the personal lawsuit is $300k, too bad, the LLC is still only paying out $50k, and your personal assets are still 100% protected.
Now--before you LLCers start thinking that you're INVINCIBLE and all, nothing...I mean nothing is going to protect you or your personal assets from fraud, gross negligence, and or malicious conduct. IF you are found culpable of any of this, you better believe your lucky stars that whatever protection you might have had.,pooooOOOF... is going straight out the window.
MORALE OF THE STORY!? --An LLC's peronal protections are only theoretical until you have the misfortune of being at the wrong end of a personal injury lawsuit! Trust me!
No one thinks it will happen to them, until it does.
Don't let a SP be your ticking time Bomb!--if your business services the community or has heavy traffic flowing through its doors, or if you simply wish to sleep easier each and every night, form an LLC. YOUR home, bank accounts, pearly white boat...will all thank you later.
Until next time my legalites,
[This blog is intended for informational purposes only. In no way should it be construed as legal advice. Every situation is different. The comparisons and analysis below are tailored generally and do not contemplate every scenario. If you are having an issue related to the content above, you should speak to a licensed attorney].