A LLC or limited liability company is a very popular type of business entity for small business owners because it’s easy to form and you don’t have to follow any corporate formalities. In California, creating a LLC is as simple as filing a one-page form with the California Secretary of State. However, the ease of formation is both a blessing and a curse.
One of the main reasons business owners create a business entity in the first place is to protect themselves against personal liability. This means, if something goes wrong with your business, you are not personally responsible. This is because a LLC is considered a separate legal person, so its obligations are separate from yours.
However, simply filing the articles of organization with the Secretary of State is not enough to demonstrate that your LLC is a separate legal entity. You have to run your LLC like an actual business that is independent of yourself.
Here are some tips to ensure that your LLC gives you the protection against personal liability that you’re looking for:
Keep Your Funds Separate
One of the first things I have my clients do after filing the articles of organization is to get an EIN. Using this EIN, you want to create a bank account for your LLC.
Now that you have a LLC bank account, you want to keep your personal money separate from your LLC’s money. That means all money generated by the LLC should go into the LLC’s bank account. The LLC should pay off its own debts and obligations and the LLC’s funds should not be used to pay off any of your personal debts. You also shouldn’t pay off the LLC’s debts using your own money. In addition, you should only enter into contracts on behalf of the LLC in the LLC’s name and into your own contracts, in your own name.
Document Your Decisions
Unlike a corporation, a LLC does not have required formalities. While a corporation requires formalities such as a separate board to oversee the activities of the corporation, annual meetings to discuss the corporation’s affairs and elect directors, meeting minutes to be recorded at every meeting, and board resolutions to document decisions, a LLC does not. However, it is still a good idea to document your LLC’s decisions and the authority under which those decisions are made.
Have an Operating Agreement
An operating agreement is an agreement between the members of the LLC of how the LLC will be run. It is a playbook of how to run your LLC. If you run your LLC according to your operating agreement, there is a higher likelihood that you will be protected personally. When you have an operating agreement, it adds a level of formality to your LLC, making it look more like the LLC is a separate entity, rather an extension of yourself.
California does not require LLCs to have an operating agreement, but when you don’t have an operating agreement, you are agreeing to operate your LLC as specified by the state. That requires you to know the state’s laws and to act accordingly. It is much easier to look at your operating agreement to see how you should run your LLC than to decipher how you should run your LLC according to your state’s laws.
Be Careful About Personally Guaranteeing Your Obligations
Finally, you should be aware that some creditors require owners of LLC’s to personally guarantee the LLC’s obligations. For example, many banks require small business borrowers to personally guarantee their loans and sometimes even place a lien on a business owner’s home. This is because there is a high failure rate amongst new businesses and the creditor wants to ensure that it gets paid even if the new business fails. However, if you personally guarantee a loan, the creditor can go after you personally if the LLC cannot pay, and it jeopardizes some of the personal liability protection you get from creating a LLC.
If you have questions, we are here to help. You can schedule a free strategy session with us by clicking here.
This article is provided for informational purposes only and should not be construed as legal advice. Read our disclaimer here.