Let’s talk about one of the most important reasons that a business owner will form a legal entity to house the business in the first place, which is to limit liability.

Corporations and Liability

A corporation is an independent legal entity created under state law with a legal existence that’s separate and distinct from its owners. Corporations really are the most widely accepted and well-established entities for investors to protect themselves from personal liability for the actions and debts of a business.

You must make sure to comply with all the corporate formalities. That means there’s no evidence of of an alter ego to the business owners, you’re maintaining accurate corporate records, you’re not intermingling corporate and personal assets, you’re maintaining an arm’s-length relationship with related parties, and you’re papering proper board and stockholder approvals.

Generally speaking, a stockholder of a corporation will only be held personally liable for the actions and debts of the business up to the amount of such stockholders’ investment, regardless of the stockholders’ involvement in the management of the business.

LLCs and Liability

Like a corporation, an LLC is an effective shield against personal liability, subject to one caveat: there are some courts that have held that a single-member LLC—in other words, an LLC that just has one owner—is not protected against personal liability. So single-member LLCs can be a little tricky and advice from legal counsel is strongly recommended.

The bottom line is that corporations and LLCs really both provide a good shield against personal liabilities for the owners of the business provided that the business owners pay attention to the appropriate corporate formalities.