So, you just started a business (or are seriously thinking about it).
Or maybe you’ve been running your business for a while, and it’s picking up steam. You’re thinking, maybe it’s time to make sure your business is set up properly.
There are a few different business entities you could choose for your business. The most common for beginners is Sole Proprietor. If you’ve already been in business a while but haven’t formed an entity (LLC or Corporation), then you’re likely a Sole Proprietorship.
The next step for most small businesses once they start growing is to form a Limited Liability Company (LLC).
This article walks you through 4 signs that your business is ready for that next step and you should consider forming an LLC.
1. You have a business partner
When multiple people operate a business together without an LLC or corporation, the law says that this is a partnership by default. The partnership is formed as soon as the partners agree to start the business. There are default laws (that vary slightly by state) that control how a partnership runs and the legal rights of the partners.
In a partnership, when there is no partnership agreement, the partners all share equally in all profits and all losses of the business.
If you have a partner or a couple partners, you may have contributed different assets or skills to the business. Maybe you don’t want to split everything 50/50 because one person invested less time or money in the business than the other.
If you create an LLC, each partner (now called a member) can have a different ownership interest in the LLC (60/40, or 20/20/60).
If your partner goes out and gets a loan for the business without your knowledge, you are personally responsible for that debt as well. Meaning the bank can take your savings if the business can’t pay back the loan. In an LLC, only the LLC would be responsible for that debt, and your savings would be safe.
2. You have a family or significant personal assets
The biggest reason to form an LLC is for the liability protection it provides. When your business is an LLC, the obligations of the business can’t spill over into your personal life. This means if the business has a debt, the creditor can only collect from the business, not from you.
In a Sole Proprietorship, everything is up for grabs (including your house!). If you have a family you want to protect or an inheritance from Aunt Mildred you don’t want the bank to get a hold of, it might be time to form an LLC.
I don’t say this to freak you out! Most small businesses just starting out don’t have the kind of liabilities (big loans, risky deals, huge contracts) that make it likely they could lose personal assets to a creditor of the business. Consider your own situation and assess the risk in your business.
3. You’re hiring employees
Employees always come with extra liability. First, you have to pay them. Next, there’s more potential for mistakes and lawsuits with more people working for the business. And it also means your business is growing, so there’s more money and more risk to manage in general. An LLC can protect you from that additional risk.
4. Your business needs to carry some debt
As mentioned above, when you are a sole proprietor (you run a business under your own name or a trade name), there is no legal distinction between your personal assets and your business assets from your creditors’ perspective.
If you need a loan for your business, you might want to consider forming an LLC to shield your personal assets. However, most banks will require a personal guarantee (“if my business can’t pay the loan, I will”) from you if you’re just starting out anyway.
Basically, it all comes down to liability. Is there anything in your business that increases the risk that you could get sued or lose money? If so, you might want to separate your personal assets from your business by forming an LLC.