Learn which business structure is best to protect your assets.
I was recently asked an absolutely fantastic question: I’ve heard that I don’t need an LLC if I have good insurance. So what’s the point of an LLC?
Here’s the short answer: Forming an LLC is the easiest and most cost-effective way to protect your assets.
You’ve worked hard to get where you are, and I know you want to protect what you’ve earned. So keep reading to find out why an LLC might be the best choice for you and how it compares to having a different type of business structure, like a sole proprietorship, with insurance.
What Is a Sole Proprietorship?
A sole proprietorship is basically like it sounds: a person operating a business as themselves without actually forming a business entity.
Those who operate as a sole proprietorship may be doing so because they are not aware of the options they have in terms of structuring their business. Sole proprietorship is the default if you haven't taken any steps to form another type of business entity.
But, from a legal perspective, when you operate a sole proprietorship, you are your business, and your business is you.
From an asset protection perspective, a sole proprietorship is the riskiest structure to use to run your business. If someone sues your business, then you will be personally responsible for any costs and/or damages emerging from it. That means that your personal assets (the things you own, like your house, your personal bank accounts, your vehicles, etc.) can be taken by creditors.
What Is an LLC?
If you’ve already read this blog post, you’ll probably be familiar with the basics of some business entities, but for those who might be unfamiliar, an LLC (limited liability company) is a type of formal structure for a business.
An LLC protects your personal assets (everything you own, for example, your house, bank accounts, and vehicle) if your business is sued.
It is a type of business entity that allows business owners to limit their liability in business dealings. In an LLC, a business owner is not personally liable if the business is sued. Basically, it means that if someone is suing the business, they can go after your business assets but not you personally (it gives you and your money some protection).
The LLC be used to run your business or simply to hold your assets (as mentioned before, your house, vehicles, etc.). They are easy and cheap to set up and also simple to maintain.
Mid-blog post check-in: sole proprietorships offer absolutely zero personal asset protection, while LLCs ensure that only the business and any assets owned by the LLC are reachable by creditors.
But what if I run a sole proprietorship with good insurance? Isn’t that good enough?
First of all, it’s important to have both personal insurance as well as business liability insurance, no matter what type of structure you operate your business under.
But I can tell you this: having an LLC with business liability insurance is a much stronger structure than a sole proprietorship with business or umbrella insurance.
As a reminder, sole proprietorships offer no personal asset protection. Even if you have good insurance, as a sole proprietorship being sued, it would mean both your business and personal assets are at risk—and even “good” insurance may not cover your debts and liabilities.
Further, you might end up paying more for your personal liability insurance if you haven’t set up an LLC to protect your assets.
What about corporations? Is it okay to have a corporation with insurance, or do I still need to form an LLC?
Somewhat similar to LLCs, corporations have some liability protection. The owners of the corporation are not personally responsible for any debts and/or liabilities the business incurs should it be sued.
However, one reason to consider forming an LLC instead of a corporation would be to prevent double taxation. Double taxation is where income is taxed at the corporate level and then again at the shareholder level.
For example, let’s say Corporation 123 makes a profit of $1 million in a year. It keeps half of that, $500,000, in earnings, and pays the other half in dividends to shareholders of the corporation. Now, let’s say Jane is a shareholder of the corporation and receives $20,000 in dividends. Corporation 123 would have paid tax at the corporate rate on the original $1 million, but Jane, on her personal/individual income tax, will pay even more tax on the $20,000 she received in dividends.
When you're the only shareholder of the business, that effectively means that you're paying taxes twice: once on your business profits, and once on the income you take from the business.
As always, there's an exception to the rule: learn more about S-Corp election here.
Another reason to consider forming an LLC instead of a corporation is that corporations can be costly and complicated to run and maintain. Corporations have strict guidelines, for example, they are required to have a board of directors, hold annual meetings with meeting minutes, and have more complicated tax requirements.
But, in terms of asset protection alone, a corporation with business liability insurance will suffice.
To sum up...
- Sole proprietorships are businesses run by one person who has not formed a separate business entity.
- Sole proprietorships offer no personal asset/liability protection.
- LLCs (limited liability companies) place a wall between you and your business. They ensure that in the event you are sued, creditors can’t come after your personal assets (your car, your house, your boat, etc.).
- LLCs are low cost to set up and easy to maintain.
- Corporations offer asset protection, similar to an LLC, but can be expensive and difficult to set up and maintain.
- Between an LLC and a sole proprietorship with insurance, an LLC offers the best asset protection.
- An LLC with business liability insurance is the strongest structure to choose to protect your assets.
(Note: If you’re interested in changing over your sole proprietorship to an LLC, it’s a pretty quick and simple process. You’ll need to file some paperwork with whichever state you intend to form your LLC in. A quick google search will help you find the appropriate paperwork. You’ll get a new EIN (Employer Identification Number), then you’ll need to take care of a short list of “to-dos” (like canceling your “doing business as” or trade name, transferring your assets from yourself to the LLC, updating your contracts, etc.). Et voila!)
There are 5 other steps you can take to protect yourself, and you can learn them all through the free masterclass I’m currently teaching. Some of them include:
- Learn how to avoid 3 big mistakes that are putting your revenue at risk
- Figure out how to put the right policies in place on your website so you’re legally protected
- Learn how to protect the content you create through trademark and copyright
and more—once again, all for free.
For other ways to protect your money and business, watch the free masterclass: How to Legally Protect & Grow Your Online Business So You Can Keep More of the Money You Make