Protecting Your Limited Liability: A Guide for Entrepreneurs

Running your business as a corporation or LLC offers one of the biggest advantages: limiting personal liability. This means your personal assets are protected from business debts and obligations, unlike a sole proprietorship or partnership. However, if you’re not careful, you could lose that protection. (Learn which entity structure is right for you.)

Here’s how to ensure you limit personal liability.

What Is Limited Liability?

When you operate as a sole proprietor or partnership, you’re personally responsible for all business debts. If you fail to pay a business loan or break a lease, creditors can come after your personal assets, like wages or property.

With a corporation or LLC, it’s different. If the business can’t meet its obligations, only the business is liable, not you personally. This is the foundation of limited liability and a key reason many entrepreneurs choose to incorporate. Most states, including Colorado, Kansas, and Missouri, follow this general rule.

However, limited liability isn’t automatic, and courts can set it aside under certain circumstances.

When Limited Liability Can Be Lost

Courts may “pierce the corporate veil” and hold you personally responsible for business debts if they determine that your business is not truly separate from you. 

Here are the most common reasons this happens.

Committing Fraud or Wrongdoing

If you commit fraud or wrongdoing while expecting your business entity to protect you, courts won’t allow limited liability to shield you from consequences.

Commingling Personal and Business Finances

If you mix personal and business funds, courts may decide your business isn’t a separate entity. This is common when small business owners use their personal checking accounts for business transactions. To avoid this, always maintain a separate business bank account and ensure your company has enough funds to operate independently. If you happen to pay an expense using your personal funds or credit card, you can reimburse yourself as long as you document it correctly. Learn how to set up a business bank account.

Failing to Follow Corporate Formalities

If you don’t maintain an operating agreement (for LLCs) or bylaws (for corporations), document company meetings, or sign contracts properly, courts may decide your company isn’t functioning as a separate entity. This can put your personal assets at risk.

(Note: You are always responsible for your own actions. For example, if you cause an accident while driving for work, you can’t claim “my LLC was driving.”)

How to Limit Personal Liability

The good news is that the process to limit personal liability is straightforward.

Keep Business and Personal Finances Separate

• Open a business bank account and use it exclusively for business transactions.
• Avoid paying personal expenses from your business account or vice versa on a regular basis.
• Maintain proper financial records.

Follow Business Formalities

• LLCs should have an operating agreement.
• Corporations should have bylaws and documented meetings.
• Keep a record of major company decisions.
• Sign all contracts in the company’s name, not your personal name.

Work with a Knowledgeable Lawyer

A startup or small business lawyer can help you establish your company properly and ensure you’re following corporate formalities. They can assist with setting up an operating agreement or bylaws, maintaining a digital minute book, and advising on tax filings and contracts.

By taking these steps, you can protect your personal assets and keep your business liability truly limited.

*This article is general in nature and is not legal advice.