Liability Advantages of an LLC vs. Sole Proprietorship

Written by Wesley Henderson

October 8, 2020

Company “X Man” is a handyman services company owned by Bill. Bill operates the company out of his home. He has a van with equipment. His brother suggested he set up an LLC, but Bill figured he’d get to it later. One day, Bill was fixing a hot water heater in a customer’s attic when he received a call that his mother had fallen ill. He dropped what he was doing and rushed out of the customer’s house. Unfortunately, moments later a child climbed up into the attic and the water heater fell onto the child, causing severe and permanent injuries. 

What are the liability protections for “X man” and Bill? 

Well, a bad day worsened. Not only did Bill’s mother suffer a heart attack, but a child was injured because of Bill’s negligence. He did not have an LLC (or other liability shielding business entity), so the prevailing lawsuit hit Bill hard. He lost his business, including his van and all his tools. He lost his house and his boat as well. Even after selling all his assets, Bill still owed $500,000 and the lawyer for the boy seemed determined to collect for her client. 

What are the Liability Advantage of the LLC vs Sole Proprietorship if Bill Had an LLC? 

If Bill had taken the time to set up an LLC he may have been protected from owing personally on the injury. His business would have taken a hit, but his house and boat would have been shielded from liability provided he took the necessary steps (treated the business separate from his personal assets, did not commingle funds, etc. – read more about this here). 

Setting up an LLC would have cost him a little time and money, but certainly would have been worth it. Let’s consider another example. 

Business Debts of an LLC vs. Sole Proprietor

“X Man” company was doing much better than Bill ever anticipated. In fact, he hired an entire crew to assist. Bill and his crew were so successful one of the local builders in town hired him to paint a 1,000 home subdivision. In response, Bill bought a paint pumping truck for $250,000.

Unfortunately, the “Alligator Flu” swept across the world. In its path, the flu left many ill and unable to work. It also shut down the economy of Bill’s town, including the new development. Nobody wanted to spend money on home improvements or painting. Bill was forced to layoff his crew and defaulted on the paint truck. The paint truck company demanded it’s money. 

Under the circumstances, if Bill had a proper LLC, then only the company would be obligated to pay, which would provide Bill numerous options – he could file bankruptcy or force the company into a delayed payment plan. 

Other Considerations for the Liability Advantages of an LLC vs Sole Proprietorship

Most businesses need either an LLC or an appropriate liability shielding form of business – corporations and certain partnerships, for instance. Without liability protection, a myriad of problems arise. Here are a few problems when companies form without the proper business structure (i.e. sole proprietors instead of LLCs): 

  • Risk – Few people want to take a risk on a new business venture where risk is endless
  • Capital – It is hard to find investors and raise capital 
  • Stress – The stress of operating a business is enough without worrying about the vulnerability of personal assets. 
  • Taxes – Sole proprietorships can only be taxed as pass-through entities while other forms of business, like the LLC, have multiple options. 

Conclusion 

Too often hard-working people dive right into their business and helping people without considering the legal consequences. It’s easy to do all the correct things: Set up an LLC, purchase insurance, draft contracts. With help from a trusted source like Drafted Legal you and your company will be on the path to success. 

If you and your business partners need help setting up your LLC or learning more about entity formation, visit www.draftedlegal.com for more information. We’ve made it easy to set up your business easily and quickly while equipping you with the tools you need for success. Don’t zoom through your legal, get Drafted. 

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