One more time – we are going to talk about the Limited Liability Company or LLC. I have been getting a lot of questions lately that all basically boil down to the question: “is it necessary for me to set up and LLC or sole proprietorship?” The answer to such s general questions is — it depends. Really the only time that it depends is when you are thinking about setting up a corporation, limited liability partnership, or professional corporation/partnership/etc. If your default is to be a sole proprietor or a traditional partnership, then the answer is always YES, you must set up your LLC.
There is one gigantic reason trumping all others to run your business as an LLC instead of as a sole proprietorship or traditional partnership — LIABILITY! I have said this plainly on several occasions, so let’s illustrate it this time with an example. There are twins named John and Jack, their father is a chef and restaurant owner. They both grew up cooking ever since they could reach the stove, and both are award winning chefs at their father’s restaurant; they decide to each open up a new restaurant. John opens up restaurant #1, an LLC. Jack opens up restaurant #2, a sole proprietorship. A tainted ingredient makes it into the food one day and a person at each restaurant ends up sick and hospitalized with healthcare bills of $300,000.00, with pain and suffering to add to that. John and Jack each get sued and judgments are entered for $500,000.00 against each of them. The restaurants are new and only have $100,000.00 in assets that can be reached by a lawsuit. Each brother has $500,000.00 in reachable assets from their personal savings, etc. What happens?
Jack owns restaurant #2, a sole proprietorship. The $100,000.00 in assets of the restaurant that can be reached by judgment are taken, then the remaining $400,000.00 was taken from him personally, leaving him with $100,000.00 of personal money. John owns restaurant #1, a LLC. The $100,000.00 in assets of the restaurant are taken; moreover, it is likely that the person who won the judgment against him agreed to release the judgment for that because that was all that they could collect. He still has his personal $500,000.00. He was never at risk to lose his own money because his LLC limited his liability.
Jack felt more comfortable with a sole proprietorship because he felt like an LLC would be a hassle—he knows cooking, not law. He didn’t want to deal with the form which he thought would be complicated. He didn’t want to deal with the tax authority in his state and other possible regulations, although he still had to deal with the ones covering his business or risk being in even greater trouble. He also thought he could get sneaky on his taxes and keep more money. He didn’t think about the fact that he would always be sued personally for anything that happened and would always be personally responsible for the entire business. From day one, he set himself up to get burned. John filled out the LLC paperwork, it was easy, in many states it is only a few pages and doesn’t require a lot. He did what he was told to do in letters from agencies to report what he needed to. It wasn’t very hard and from day one but he was personally protected.
There are reasons why you may want to go with a corporation or another type of entity and we will talk about those in another article. There is however no reason why you would ever go with a sole proprietorship or traditional partnership. Good business people take calculated risks, they are not wholesale gamblers. For what is typically a few hundred dollars – filling out a form, and spending one to four hours a year with other paperwork that is sent to you, you can protect yourself from being in Jack’s situation. That little bit of time and money is the safest gamble you have in business — it is a sure way you can give your personal wealth, credit, etc. a massive wall of protection. Why would you ever consider not doing that?