What is limited liability?
When I started at UNeTech Institute last fall there were lots of terms my co-workers used that I simply did not know because I was new to the world of startups and entrepreneurship. My colleague Jace and I used to slyly Google terms on our iPhones as we listened to researchers or incubator CEOs speak on Zoom meetings.
Eventually it occurred to me that there must be others out there who also need some help unpacking some of the basics of the jargon associated with this new field that I have found myself in, and so I present to you a new series for this blog.
Welcome to What is … a blog series where I will define for you all the words and phrases I had to Google when I first was hired. I will bring in some smart folks to explain in lay-person terms what these things mean and why we should understand them. There will be no rhyme or reason to how I present them. Basically, any time Jace or I have to look something up, it is fair game to add it to the list.
What is limited liability?
This was a tough one because when I looked it up it led me to need to look up even more words. The associate director of UNeTech, Joe Runge, is a lawyer. And frankly, sometimes he forgets that no one else who works here has a law degree. He will throw around legalese about patent law. And often I will simply tell him I do not understand what he means. But many times he leaves my office, and I will just look up what he said.
Limited liability is definitely a concept I had to look up to make sure I understood it completely. The way a business is structured determines three main things: who owns the business, how its taxes are paid, and who is liable if a debt arises.
Who owns the business?
According to Small Business, the owners of an LLC are called members. Each member is an owner of the company — there are no owner shares — like with a corporation. To form an LLC, you file Articles of Organization with your state office.
How are its taxes paid?
An LLC is most often treated as a pass-through entity when it comes to federal income tax, which means that the LLC is not required to pay any tax on business income. Instead, the members of the LLC pay tax on their individual shares of the of LLC’s profits.
Who is liable if a debt arises?
In a limited liability company, (an LLC), shareholders in a company are only liable for the money they invest in the company. And only that money can be used to pay off the company’s debts, including if the company is sued.
Small business attorney Homero Vela from Barkdoll & Von Ahsen, LLC, is my buddy from our theatre days together at Creighton. (He studied technical theatre while I studied directing.) When I have legal questions, I often call Vela and ask him to break things down for me simply, the way he would to a first-year law student. He explained this liability concept to me in a way he thought I would understand.
“In practice, limited liability means that your corporation, LLC, and Limited Partnership can be sued by any claimant, and as long as you have followed all the relevant corporate formalities, the claimant will only recover, at most, the assets of the company,” Vela said. “This also means the claimant cannot recover your personal assets, such as your house, your car, and your stuff.”
Vela gave me this example:
“Setting aside any insurance policy your business might have, if you were negligent in repairing a sinkhole in front of your business and a member of the public fell and sustained an injury, that person could sue your business for damages,” Vela said. “If you were a brand-new business and had just contributed $10,000 to the entity, and the entity had no other assets, the injured person could only recover $10,000, even if their medical bills totaled $50,000.”
Vela’s final thoughts on limited liability? You can lose its status if you are not careful. “There are a multitude of ways to lose limited liability, including failing to follow corporate formalities, being undercapitalized, and operating as a “sham” business,” Vela warned. “Therefore, it is vital to consult with legal counsel at least yearly to ensure you maintain your company’s limited liability.”
Overall, a limited liability company is one way you can structure your new private business. It will make sense for some businesses, and it will not make sense for others. Hopefully, this blog post helped you understand at least the basics of who will own your LLC, how its taxes will be paid, and what will happen if a debt arises in your LLC.