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Why do business owners use LLCs to address debt?

On Behalf of | Jan 14, 2025 | Business

Many businesses take on a substantial amount of debt. For a lot of business owners, even if they have properly identified their target audience and created an effective business plan, they still need loans at the beginning to start the company and get it up and running. They then repay these loans once the company becomes profitable.

In some cases, business owners establish their businesses as LLCs, or limited liability companies, specifically to address the debt they take on when launching their business. Why is an LLC advantageous compared to a different business structure, such as a sole proprietorship, when it comes to accruing debt?

Personal liability

The key difference with an LLC is that the company itself is the only entity responsible for the debt. With a sole proprietorship, the business owner could be personally liable. Essentially, the LLC structure separates the business from its owner. It may be confusing to think of it this way if the person who creates the LLC is also running the business, but in the eyes of the law, the business and its owner(s), personally, are separate and distinct. 

For example, say a company takes out $1,000,000.00 in loans to start the business, but has to close after just a few years. Upon closing or winding up, the assets are liquidated and the company finds out that they’re only worth about $500,000.00. If the company was a sole proprietorship, the business owner could still be personally liable for the remaining $500,000.00. Due to this personal liability, creditors could pursue personal assets of the owner, such as bank accounts, investments, or real estate—like a family home (subject to Florida homestead protections). 

However, if the business was an LLC, likely only the company would be liable for paying off the debt. That means that creditors could recover their $500,000.00 from the business assets, but it would likely end there as there is nothing left to go after. They wouldn’t be able to take personal assets of the business owner.

When might an LLC not provide personal liability protection?

Often times, if the business is new, a lender might require the individual business owner to co-sign or guaranty the loan. In this situation, the owner would be personally liable for the company’s debts and his or her assets could be at risk if the company were to default on the loan.  

Another situation where the LLC structure might not protect the owner, personally, is if the creditor attempts to “pierce the corporate veil.” This is a legal concept that allows the creditor to go past the LLC shield and go after the owner individually. There are very limited situations where a creditor will prevail when trying to pierce the corporate veil, with most of these situations arising when the business was merely a shell company created for protection of the owner. Specifically, this happens in situations where the business owner never intended to actually start and operate a business, but was merely using the LLC structure to try and shield him or herself from personal liability. How can you avoid the corporate veil from being pierced? Simply run the business. If you start an LLC and actually run the business, the creditor would likely not be able to pierce the corporate veil. This is a complicated subject and one for a different blog, but it is important to point out that the LLC structure is a fantastic tool to protect business owners, but is not designed to be abused.   

Sole proprietorships and LLCs are just two examples of potential business structures, each with their own pros and cons. Those starting new businesses need to understand the legal steps they can take and the options available to them in the planning stages to ensure they are most protected once the business is up and running. Here at Corey Szalai Law, PLLC, we help clients understand the pros and cons of all business structure types and determine which one is best for them. We also help discuss which one provides the most protection for their personal assets. Call us today to schedule a consultation to see how we can help you get your business started.