Most Business Owners Are Not Personally Liable for a Company’s Debts
If a business is organized as a corporation, limited liability company (LLC), or other type of separate legal entity, the owner is not liable for the debts of the business unless other conditions exist. For small businesses, the primary reason the owner took the time and expense to set up the separate legal entity was to prevent being personally liable for business debts.
Historically, when an individual started a business, such as a cobbler, blacksmith, or street vendor, the business and the person were one and the same. These businesses are known as proprietorships, and in these cases, the owner is personally liable for all of the business’s obligations.
As we all know, it takes money to start, grow and run a business. The concept of corporations came out of the need to raise larger amounts of capital to fund larger businesses, which meant the need for multiple investors. Since most investors were not actually involved in running the business, they wanted to limit their liability to the amount they invested. When you buy a share of stock in Apple or IBM, the most you can lose is what you paid for the stock, regardless of how much money the corporation might owe to vendors and lenders. The corporation is a stand-alone entity completely separate from the owners, managers, and employees, and therefore the owner is not liable for the business debt absent other circumstances.
There is some chance you can pierce the corporate veil to create personal liability as we explained in an earlier article. Given that this can be an expensive and difficult process with uncertain results, it is not a great alternative in most cases.
An individual is liable for a corporation’s or LLC’s debt if they provide a personal guaranty to the lender or vender. This needs to be a written document specifically stating the individual is guaranteeing the obligation and then signed by the guarantor as an individual and not as an owner or officer of the company. A personal guaranty can easily be included in a credit application. An email or letter where the individual ‘promises’ you will get paid is not a valid personal guaranty and does not create personal liability.
As a commercial collection agency specializing in large claims, we always prefer to have a personal guaranty. It gives us more leverage to make our client’s invoices a higher priority regardless of the company’s financial situation.
About The Author:
Dean Kaplan is Principal at The Kaplan Group. Dean's expertise is widely recognized in the debt collection industry. His advice has been published in a number of industry newsletters such as Credit Today and InsideARM and he is a frequent speaker at industry events.