Understanding Founder Liability

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.

A common question I get from founders is what their personal liability will be with regard to their startup. Limited liability entities, such as corporations and LLCs, do insulate personal liability to a certain degree.  However, that protection is not absolute, and should be understood by founders of a company.

When a Founder Can Be Liable

1. Personal Conduct Might Make Personal Liability

A founder, employee, or any other person working with the company may incur personal liability for their own conduct.  For example, a data security consultant that gives horrible advice resulting in a data breach could be liable for negligence. Likewise, a company actor could incur liability for his or her own intentional misdeeds.

The company may also be “vicariously” liable for the company actor’s actions if they were within the scope of employment.  The vicarious liability of the company does not, by itself, relieve the company actor of liability.

2. Director and Officer Liability

Founders that serve as a director and/or officer are obligated to exercise their duties with a duty of care, meaning they exert a reasonable amount of prudence in making decisions, and loyalty, meaning they act with the company's best interests in mind.  Failure to exercise these duties could cause the officer/director to become liable to the company's shareholders for any damage the failures cause to the company.

When a Founder is Generally Not Liable

Company Liabilities Are Company Liabilities

Certain types of liabilities belong only to the company.  If, for instance, the company becomes insolvent and cannot pay its creditors, the liability will belong solely to the company.  Other contractual liabilities and obligations also belong solely to the company.  Employment obligations such as unpaid wages are the company’s obligation, as well.  Founders will typically not be responsible for these matters unless the corporate veil is pierced, which requires a finding that the company was being used for fraudulent purposes or neglected to follow corporate formalities (i.e., paying taxes, holding meetings).

Practical Steps

One way that companies protect employees, directors and officers is through Indemnification provisions in the by-laws.  Another way the company may protect the officers and directors is through directors and officers insurance (D&O Insurance). Apart from this, founders may take care to ensure that: (a) the company is following corporate formalities to mitigate the likelihood of having the corporate veil pierced, and (b) the founder is not acting in a way that is injurious to third parties.