A Limited Liability Company (or its cousin the S-Corp) can be a valuable tool for protecting personal assets by separating the entity from its owners for both tax and legal purposes.  In doing so a “corporate veil” is created.

But just like a properly-insured driver can’t drive with impunity and reckless abandon so too must a business owner not be sloppy with business practices.  Otherwise he/she runs the risk of “piercing the corporate veil” and putting personal assets in danger.

What does it mean to pierce the corporate veil?

When a creditor or plaintiff convinces a legal authority that business and personal assets are not truly separate.

What’s the result?

A loss of asset protection.

What’s the risk?

Creditors of and plaintiffs against the business can seek to collect against personal as well as business assets.  Similarly creditors of and plaintiffs against the individual can seek to collect against business as well as personal assets.

What steps can be taken to mitigate the risk of piercing the corporate veil?

Don’t do something stupid!

  • If your name is John Doe don’t name your business “John Doe.”  John Doe Enterprises, John Doe Associates, JD Inc, are all fine.  Just don’t use “John Doe.”  (For those who want an extra layer of protection avoid using any name variation.  XYZ Corp is just as boring as John Doe, Inc. yet slightly more effective.)
  • Don’t fail to document start-up costs.  Most often personal assets are used to capitalize the business.  Make sure the contribution of personal assets to the corporation is properly documented.
  • Don’t commingle assets.  Use business assets for business purposes and personal assets for personal purposes.  If you’re going to use business assets for personal purposes make sure you reimburse the company.
  • Make sure the business serves its purpose.  Every expense from travel to equipment and so forth should clearly serve the entity.  If your company imports shoes from Italy then a trip to Italy to visit a supplier is reasonable.  An African safari under the guise of finding a new supplier is a red flag.
  • Don’t have one LLC benefit another.  Let’s say you own two LLCs.  LLC #1 is a landscaping business.  LLC #2 is a bakery.  It’s fine if LLC #1 uses funds to buy a lawnmower.  It’s a bad idea if LLC #2 does.  A plaintiff/creditor could argue the “independent” companies act to benefit one another and then seek to collect against both of them.
  • Don’t skimp on proper corporate functions.  Companies hold meetings and keep minutes.  They document what they’re doing and why.  Do the same.  Take actions that show the LLC is operating like a company and not as a legal shell for the owner/individual.

There’s no binary solution.  It isn’t as simple as “if you do X then you’re bulletproof.”  You can, however, take the above steps (and more) to ensure that your LLC looks and functions like a true corporation.  The more you can show the LLC is independent of the owner the more you can justifiably argue personal and business assets are separate, “safe” and protected.