Let’s talk about Limited Liability and why it might matter to you if you go into your chosen profession.
Limited Liability Defined
Limited Liability is legally defined as: “liability of a company’s owners for nothing more than the capital they have invested in the business.”
What does that even mean?
It’s how the rich stay that way. It’s how entrepreneurs have more failures than they have successes.
Limited liability protects the personal possessions (houses, cars, saving accounts) of the owners from being used to pay for any debts, judgments, or other financial obligations created by the entity that offers limited liability (we will talk a bit more about entities in a second).
Limited Liability is discussed so much in the startup world because it is one of the most important factors you should consider when choosing an entity for your company. A business entity that offers limited liability, limits the liability of business owners to their investment in the company. That means, if you start a business that offers limited liability, creditors cannot go after the personal assets of the owner (e.g. a savings account, car, or house) to collect on any money owed by the business. This is true of loans, accounts of the business, and lawsuits. If the owners’ liability is limited by the entity selected at the beginning, creditors can only collect money or assets inside the business.
This matters both in the success and failure of a business. If a business is successful, it can become a target for lawsuits. Many successful businesses have been dismantled by one lawsuit that bleeds the business dry. If the business goes under because of the lawsuit, creditors are out of luck because creditors cannot take your personal assets into account to satisfy any business debt they are seeking to collect. Often, a business can run out of money during a lawsuit before any judgment happens because of the cost of litigation (even if there is insurance to cover some of the cost). That means if your business struggles for a time after a lawsuit that cost more money than you anticipated, the creditors cannot look to your personal assets (or other sources of income) to collect the judgment they won. Your liability for the judgment of the lawsuit is limited to the business. That means, a struggling business does not mean the owners are struggling. A business may have a difficult time satisfying some of its debts, but the owners continue to live in the manner to which they have grown accustomed because they properly limited their liability in each of their business ventures.
The protection of limited liability is also important if a business fails. Dissolution of a failed business is like probating a business. The assets of the business are divided to pay off any existing creditors (or as much as they can) and the owners continue on with their lives. That means if a business fails and is forced to shut down, the creditors go with the business. Creditors must be paid before the owners get any money, but creditors cannot go after any owners personally for debts incurred in the business. In the failure of a business, limited liability gives an owner the ability to choose to shut down an unprofitable business because it makes sense, rather than keeping it going because the owners do not want to have the creditors start coming after them.
The concept of limited liability is how successful people keep their money. So, that is how limited liability is defined.
Why Does this Matter to You?
So, you might be asking, what does this have to do with me? I am studying Health Administration. I’m not going to own a business.
You are going into a profession that could cause a business owner to rely heavily on you.
Many of you will work in larger organizations and not work personally with the owners, but some of you. A lucky few, may find yourself working closely with an entrepreneur who happens to have a vision for a clinic just like the one you are working on in this class. Let’s talk about a couple of places liability protection could affect you if you are working with a business that does not have limited liability:
Before an entity is formed (if you have convinced the owners to form the entity), anything you personally do to further a business plan is not protected until you have formed an entity. Someone working for a business before an entity has been formed is called a “Promoter”. Under the law, promoters are personally liable for anything they agree to before the entity is formed. Do not, under any circumstances, sign any contracts or incur any liabilities before the formation of the entity that offers you limited liability. Especially if you aren’t going to be one of the partners. You should have a conversation with anyone wanting you to help them form a company that they need to actually form the entity before you begin working to make sure you are not personally liable for any of the debts of the company.
If you fail to convince your future bosses to form an entity with liability protection, try to at least get your relationship with the business in writing. If your relationship with the business owners is not documented, there may be a presumption that you are a partner in the company. A partnership is two people who come together with a common business purpose with an agreement to share the profit. So, if you , in the early stages have any salary tied to the business profits (or you forego a paycheck during the early phases), you may, absent any proper documentation, be considered a partner. This can create some major issues for you because you may be personally liable for the debts of the business. This could also create problems for the actual owners of the business as you may be able to claim they owe you some portion of the profits because you were technically a partner. If a situation like this ever goes before a judge, they will start with the presumption of partnership and you or the owners will have to prove otherwise (depending on what is in your best interest). So, you can tell your entrepreneur boss that it is in everyone’s interest that all of this be cleaned up on the front end.
Whatever you do, make sure you GET IT IN WRITING.
Now, limiting the liability of the owner and promoters is one thing. Once you have actually chosen to limit the liability of the owners by forming an entity, you need to consider how to best limit the liability of the business.