Protecting Your Limited Liability: A Guide for Entrepreneurs

Running your business as a Corporation or LLC can provide you with one of the biggest advantages—limited liability. Limited liability means that your personal assets are protected from business debts and obligations, which isn’t the case if you operate as a sole proprietor. But beware—if you’re not careful, you could lose that protection. Here’s how to make sure you preserve your limited liability. ​(Related Guide: How to Choose a Business Structure)

What Is Limited Liability, Anyway?

When you operate as a sole proprietor, you’re personally liable for all business debts and obligations. For example, if you don’t pay your credit card bill or break a lease, creditors can pursue your personal assets like wages or property.

With a Corporation or LLC, it’s different. If the business can’t pay a debt or breaches a lease, only the business is liable—not you personally. This protection is what we call limited liability, and it’s a major reason why many entrepreneurs choose to incorporate. Most states, including Colorado, Kansas, and Missouri, follow this general rule.

However, there are exceptions—and understanding them is key to maintaining your limited liability.

Limited Liability Isn’t Always Guaranteed

Courts won’t automatically give you limited liability just because you have a Corporation or LLC. In certain situations, a court may “pierce the corporate veil” and hold you personally responsible for business debts and obligations. Let’s explore the common reasons this might happen.

1. Committing Fraud or Wrongdoing

The most significant reason a court may pierce the veil is if you commit fraud or wrongdoing with the expectation that your business entity will protect you. If you’re using a Corporation or LLC to engage in unethical behavior, courts won’t let you hide behind limited liability.

2. Commingling Personal and Business Finances

Keeping your personal and business finances separate is crucial. If you mix your personal money with your company’s funds, the court might decide that your business isn’t truly separate from you. This happens frequently with small business owners who use their personal checking accounts for both personal and business transactions. To avoid this, always set up a separate business bank account, and ensure your company has adequate funding to operate independently.

3. Failing to Follow Corporate Formalities

If you fail to observe corporate formalities, like maintaining an operating agreement (for LLCs) or bylaws (for Corporations), documenting company meetings, keeping a minute book, or signing contracts properly, you risk losing your limited liability. Courts may determine that your company isn’t operating as a separate entity, which can put your personal assets at risk.

(Note: You are always liable for your own actions. For example, if you are driving while on the job and cause an accident, you can’t say “my LLC was driving the car!”)

How to Protect Your Limited Liability

The good news is that preserving your limited liability is quite straightforward.

Work with a Knowledgeable Lawyer

First and foremost, work with a reputable startup or small business lawyer to help you establish your company and guide you in following corporate formalities. A lawyer can assist in creating an operating agreement or bylaws, setting up a digital minute book, and advising you on opening a bank account, filing taxes, and signing contracts correctly.

(This article is general in nature and is not legal advice.)