Are You Sure You Want to Start a LLC?
Posted on 4 Nov 2021 by RP
Everybody tells you to start a LLC.
Among other reasons, for your own protection. they say.
I’ve even published articles about starting an LLC or other forms of incorporation.
If You Start an LLC. Will an LLC Protect You?
Well, it may. Or it may not.
Here’s some conventional wisdom from a new blogging compatriot I have come across, Steve Scott. (by the way, I highly recommend you read Steve’s “Prevent a Red Sox Collapse” and his other articles).
Steve impresses me as someone who’s “got it going on”).
The article is about major disasters that can subject your business to its own “Red Sox Collapse”. Here’s one…
===>> Disaster: “I’m Being Sued!”
Yes, you can get sued when you own and operate an Internet business. It doesn’t matter if you’re right or wrong. Someone doesn’t like something you’re doing online? They’ll sue you!
Sad to say; that’s the world we live in.
==>> Is An LLC the Solution?
Could Be. Bottom line … Your entire online business should be structured through a Limited Liability Company (LLC).
An LLC is the best way to legally protect both you and your assets.
I won’t pretend to be an authority on this subject. That’s why I recommend this in-depth guide that talks about this subject. …. The Complete Guide to Choosing Your Business Structure
Like Steve, I am certainly not an expert, nor am I qualified to give legal advice, but I do have a somewhat opposing view on this overwhelmingly prevalent view of the advantages and protection offered by starting an LLC.
Here are a few things to think about, at any rate.
Start an LLC — Banking Issues
US Banking rules are pretty strict when it comes to fraudulent practices. In general, you can lose money because of fraudulent practices, but it’s thankfully quite rare.
However rare it may be, it certainly hurts if it happens to you personally, or to you via your business entity, like an LLC you own.
But do you realize that by forming an LLC and “veiling” yourself behind that business structure, you may have given up many of your built-in fraudulent practices protections?
There are 51 “laws on fraud” in the USA, including the District of Columbia’s, but here’s a quick example from New Jersey’s law that will illustrate what is a pretty common practice:
… opining that “certain practices that [would be] unlawful in a transaction that results in loss to an individual consumer [may] not be held unlawful in a transaction between particular business entities.”
As a result, the ability of a business-entity consumer to assert a claim under certain fraud statute based on a given transaction “hinges on the nature of [the] transaction, requiring a case by case analysis.”…(my emphasis)
In plain language, this means that your LLC will often have a greater burden of proof to bear in many legal matters. Think that through before you rush off to incorporate.
I also recently read of a small corporation that discovered some nefarious person had hacked into either the company’s own network, or the company’s bank’s network, or both.
Like many computer crimes, the methods were not readily apparent, but the outcome was, the corporation had been looted for all its cash and liquid investments.
They asked the bank to pay. The bank said, “No, it’s your fault, not ours”. And so, they went to court.
The judge, citing a law similar to the New Jersey example shown above, said
“If this had been a consumer fraud case, I would hold the bank liable for the full amount, but since the business involved may have unwittingly contributed to the loss, and because they, as a business, full-well knew the risks involved, I find in the bank’s favor”.
Ouch! When you are a formally organized business you are automatically held to a higher standard of responsibility in protecting your business entity from fraud.
There are many areas of banking where we, as individual consumers, literally have the backing of the Federal government.
Individuals, in the USA, at least are very strongly protected.
Corporations? Not so much.
It’s almost as if the action you took to “protect yourself” … forming an LLC, might actually leave you less protected.
Start an LLC — Credit Card Issues
In the US, federal law limits the liability of individual cardholders to $50 in the event of theft of the actual credit card, regardless of the amount charged on the card, if reported within 60 days of receiving the statement.
In practice, many card issuers will waive even this small payment and simply remove the fraudulent charges from the customer’s account if the customer signs an affidavit confirming that the charges are indeed fraudulent.
If the physical card is not lost or stolen, but rather just the credit card account number itself is stolen, then Federal Law guarantees cardholders have zero liability to the credit card issuer. The bank who issued the card has to “eat” any losses.
In short, many more people worry about credit card fraud on their personal cards than ever suffer even a dollar’s worth of loss.
However, cards owned by merchants (think an LLC) follow a completely different set of rules.
Both the merchant (Your LLC) and the financial institutions share the loss. The merchant loses the value of any goods or services sold and any associated fees.
If the merchant (you) did not get all of the necessary information they may be required to return the funds to the financial institution.
Again, I’m not really sure that using an LLC here provides the small internet entrepreneur any real protection. It almost seems as if the LLC is subject to greater risks.
Start an LLC — Court Issues
This is the big “terror tactic” most “form an LLC advocates use. “What if you get sued?
Well, for sure, getting sued is something most anyone should lose sleep over.
It will, for sure, not be fun, and will certainly be expensive, win or lose.
Again, though, I really wonder to what extent an LLC really protects an individual.
Here are two hypotheticals, based on cases that could easily come about.
Hypothetical case 1.
Internet entrepreneur “Joe” decides to “protect himself” by forming his own LLC. Joe’s business consists of a website that earns money by writing reviews of computer-related products.
Joe is totally legal in terms of his local community laws on running a business from his home. No clients visit him at home and he doesn’t conduct any aspect of his business contrary to Federal, state or local laws.
One day, however, Joe’s particularly irritable neighbor “Fred”, decides that he doesn’t like the continual daily visits of FedEx, UPS, and USPS vans coming and going from Joe’s house … delivering and picking up the review products which are the lifeblood of Joe’s business.
So Fred sues Joe’s LLC in small claims court, alleging Joe’s LLC is creating a public nuisance, destroying property values, endangering children with the traffic flow, and anything else Fred happens to feel angry about.
Well, small claims court proceedings are normally pretty simple.
The laws are usually set up so that Joe has a pretty good chance of defending himself against Fred’s emotional and possibly trumped-up charges.
One important catch.
In most states, Joe, as he has been sued as “Joe’s LLC” can NOT represent himself in small claims court, a right that Joe, as a private citizen can always avail of.
He has no choice but to hire a lawyer to represent his LLC, even in small claims court!
Bang! A relatively simple and cheap legal procedure has now turned into, at the least, hundreds of extra dollars in attorney fees and, let’s face facts here, a local, private citizen property owner, Fred, now opposing a “corporate behemoth” in the sense of Joe’s LLC.
Many judges and many neighbors are going to automatically be aligned more to the side of Fred, the “hero” who stood up against the abuse of a corporation.
Doing more research on this recently I find that many states have become more liberal in letting the members of LLC’s represent themselves in small claimscourt … but don’t bank on it.
Having an LLC make be a big problem in minor legal matters. The world loves an underdog, and you will be seen in many eyes as the big, corporate bully. This can happen. Think it through.
Hypothetical case 2.
Let’s assume Joe actually commits some serious offense of the law in the course of running his business.
Joe gets slapped with a serious lawsuit. Well, since Joe has protected his assets with an LLC, no real problem, right?
Joe’s LLC is the party being sued, and Joe’s life savings, his home, his luxury boat, and all his ill-gotten gain is safe because it’s in the name of Joe or Joe’s spouse, and Joe’s LLC itself has virtually no assets … so even if the LLC loses in court, Joe is “protected”, right? I mean that’s what all the lawyers seem to tell you, isn’t it?
Well, not all lawyers tell you that, and those who do are not always right.
Every state and the Federal government have the right to “pierce the corporate veil” and take action against the individuals who own and run a corporate entity under the proper laws.
Consider this explanation of piercing the corporate veil from the website of the Wisconsin Bar Association.
The armor of personal immunity generally shields people doing business as a “corporation” from corporate obligations. But the protection may be pierced, and personal liability imposed, when a controlling shareholder operates the corporation as an “alter ego” for wrongful purposes, or under other certain circumstances.
Similar provisions exist in all states.
If you, as the sole shareholder of the LLC commit fraud 0( or are alleged of fraud), as just one example, the chances of your LLC “protecting you” are slim. The state where the charges are made can “enter at will”, knowing that your LLC is merely an “alter ego”.
Start an LLC — So Who Is Right?
Yes, indeed, who is right?
I really feel I hold a pretty contrarian view on forming an LLC here.
So much of the conventional wisdom seems to advocate nearly everyone forming an LLC as one of the first acts they take when starting an online business.
Like all these decisions, I strongly advise you to consult a competent attorney before forming an LLC or deciding to operate “barefoot”, as a sole proprietorship.
But, assuming your legal advisor says, form an LLC, be sure you discuss the particular points from this article with him or her.
If they don’t have quick and sensible answers, I’d find another advisor, because some lawyers are so intent on getting the fees they will collect when forming nn LLC that, in my opinion, of course, I feel their judgment may be clouded.