It is all about the risk...
When I was 18, I started a tent rental business with my best friend Jay. The idea came to us after renting tents, tables, and chairs for our own graduation parties. We saw how expensive it was to rent tents and decided we wanted a piece of that action. Two months later we owned 12 plastic eight foot tables from Costco, 112 folding chairs, and two large all white party tents (because the striped tents belong in a circus, not an elegant affair like a high school graduation party.)
There were two of us. We did not form an LLC (Limited Liability Company) or any formal business entity because we didn’t want to spend the money on something we didn’t “need.” There was no formal partnership agreement, as we were two best friends who agreed to “split the work and split the profit.” We went to the Monroe County Clerk, registered the name ‘JZ’s Tent Rental’, opened up a bank account in that name, and it worked. We split all income, and a few years later when our lives were moving on we sold the tents, tables, and chairs to a friend with a similar business.
We made major mistakes, and we got lucky.
The first mistake we made was not forming an LLC. We took on this personal risk which could have cost us both our business and our friendship.
If you, as an individual, begin operating as a business without creating a formal entity, the State of Michigan labels you a sole proprietor. If you have partners, you are labeled a partnership. The problem with these business types is that there is no separation from you, the individual, and the business that you run. You are seen as one entity and are personally liable for all debts the business has. If you are facing a lawsuit, and are not an LLC, then your home, your car, and everything else you own is suddenly at risk. You could lose it all.
The risk here can come even in the most innocent of situations. Perhaps someone was injured because they decided to party a little too hard and dance on a JZs Tent Rental table while at a wedding reception. Or, perhaps we had hired a friend to pick up our tent the day after a graduation party, and our friend was in a car accident on the way home. In both situations we could have been personally liable for any injuries or damages caused, even if we weren't directly involved.
Operating as an LLC takes away that liability. The LLC becomes its own entity, its own person, separate from you. You are no longer personally liable if your business is sued. This becomes even more important for a small sized business where the extra income the business brings in may not even be worth the risk of operating as an sole proprietor.
The second mistake we made was not creating an operating agreement. As best friends we did not anticipate any problems, as many also do, and things worked out.
Unfortunately, as an attorney, I see far too often the damage that disagreements among business partners can cause. Even among friends or family. When people do not see eye to eye, and there is no system in place to make a decision, a business can become crippled and unable to act. Or, maybe even worse, it can ruin a friendship or strain a relationship with family members.
Creating an operating agreement does not entirely solve this problem, but it does lay a foundation for success. An operating agreement assigns out the roles and duties of the members (owners of an LLC). Having this legal document in place outlines how the business will be run, financial management and profit disbursement, and standard operating procedure to handle disagreements when they inevitably arise. A simple agreement can end many problems before they begin.
So the title of this article is "Why your Business needs to be an LLC." I used the example of my first business, to demonstrate how lucky I was. I simply did not know the risk I was taking. I stayed in business three years, with mild success, and could have lost everything. The risk I took was enormous. Becoming an LLC can cost as little as $250. Think about that. Two-hundred fifty dollars could save your house, your car, and any other valuable property from being seized in a lawsuit.
There are obviously other ways to protect yourself. Forming a corporation is one such possibility. However, an LLC allows for less formality and start up cost, which may ultimately be a better fit for new business owners. To learn more about LLCs and other business entities contact me today. I love to talk to new entrepreneurs about how I can help protect their investment and help them grow.
As always, this is general information. I am a lawyer, but I am not your lawyer, at least not yet. A blog post should not be construed as specific legal advice and this blog does not in any way create an attorney-client relationship.