Do I Need Limited Liability for My Business?

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice.

As an attorney, I’d tell you yes.  That is because if I tell you no, and you later incur personal liability, I’ll be subject to blame.  While the knee-jerk response from almost any lawyer will be the same, this question deserves some further exploration.

The reason why choosing a limited liability business entity is a good idea is because the owners of the entity are not liable for the debts of the business.  If, for instance, the company takes on an employment lawsuit or a contract dispute, the owners will typically not be personally liable for those debts.  If the company cannot satisfy those debts, it dissolves.

Individuals are still liable for their individual misdeeds. The limitation of liability only extends to the company’s misdeeds.  If the company enters into a contract and breaches, the company is the responsible party.  When an individual is responsible for some misdeed, the company might be liable through vicarious liability, but that does not relieve the individual from being culpable.  Often times, plaintiff’s attorneys will focus on collecting judgment from the company, because they are more likely to be able to pay.  If an individual forms an entity to shield themselves from liability, but ends up being responsible for a legal action, the limited liability entity does them no good.  They can dissolve the entity, but will still have to satisfy the judgment.  An example of this would be a car mechanic who incorporates his business to shield from liability.  If he was negligent in fixing someone’s brakes, which caused the person to crash and injure themselves, the mechanic would be personally liable separate from the corporation’s liability.

The limitation of liability also requires certain formalities to prove that a person is not using the company as a shell to shield against liability.  One of the biggest factors that courts will look at in making this determination is whether the entity was adequately capitalized or insured.  If the company was not adequately capitalized at its inception, or was otherwise used in an impermissible way, the courts will attach personal liability to the owners of the company.

In an overly simplified discussion of this issue, limited liability will protect business owners from personal liability where they were not individually responsible for the legal action and where the company followed the formalities required to maintain limited liability.  This is still a great benefit, but it does not come without costs.  

All limited liability entities in California are subject to a minimum annual franchise tax of $800 (with the exception of corporations during their first year only).  Each of these entities must also file paperwork with the Secretary of State and pay filing fees to form.  They each have state and federal tax returns to file (though pass-through taxation is allowed) and securities laws may be triggered if any investment money is involved.  For many, the protection a limited liability entity offers is a benefit that outweighs these costs, but for many, the opposite is true.  Like any other business decision, fully understanding the costs and benefits of the decision will help in making a determination.

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