Business Debt Liability

April 13, 2006

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One of the most important considerations when choosing an organizational form is the impact of liability on your structuring/funding decisions.

Most business owners mistakenly believe that assets within a corporation or limited liability company (LLC) are shielded from liability. This is certainly not the case with respect to business debts. In fact, most business owners face the greatest risk of liability from business transactions, and not personal dealings. Thus, these assets, which can be significant in a successful business, will be exposed to the greatest risk of loss. Yet, a corporation or LLC can be structured, funded and operated so that the business's assets are not exposed to any liability.

Unfortunately, today, most small business owners are not structuring, funding or operating their businesses to avoid liability. Thus, owners are unknowingly exposing their personal and business assets to a high risk of loss, many times under the illusion that their corporation or LLC will afford them protection. Typically, owners find out the truth only when financial troubles strike. At that point, usually it is too late, or extremely difficult, to preserve wealth, and the result is a significant loss of personal and business assets and, in the worst case, financial disaster.

Work Smart

You should invest and maintain as little vulnerable capital as possible within the business form, so that your "limited liability" is, in essence, further limited because you expose little or no assets to liability. This principle of asset protection is explored more fully in the section, "Limit Liability in Your Business Structure".

However, you should be aware that this strategy can trigger an exception to limited liability, in which a court "pierces the veil" of limited liability and imposes unlimited, personal liability on the owners, on the grounds that the capitalization was inadequate and was a fraudulent scheme against the business's creditors.

Fortunately, an LLC or a corporation can be adequately capitalized so as to avoid this exception, without exposing business assets to liability. Balancing the initial capital structure is critical in avoiding application of this exception.