Originally published June 2, 2017 in Rangefinder Magazine.
Let’s say you want to start up a photography business. You get a camera, make ads, and someone hires you to photograph their wedding; when it comes time to pay, they write a check and address it to you - your personal name. You cash it.
In taking these simple steps, you’ve accidentally established your business as a sole proprietorship: for all legal intents and purposes, you are the business. This is trouble. It means that if your business is sued for any reason - copyright infringement, invasion of privacy, or even simple breach of contract - then you are on the hook. Any asset you own could be taken - your house, your equipment, and your personal bank accounts.
Now, the law thinks this is bad. The law wants you to start businesses and follow your aspirations, and fewer people will turn entrepreneur if they’re afraid of losing all their money. And so we have invented limited liability corporations, or LLCs.
If you like, you can think of an LLC as being like an imaginary friend, who is also your boss. You dream up an invisible, intangible person, give them a name - let’s call ours Bob - give them a purpose - running a photography business - and then give them all the money you would spend on that purpose. When you are running your business - taking photographs, keeping your books, managing employees - you’re working for Bob, an invisible ghost-boss peering over your shoulder. And Bob’s a good boss: he’s quiet, he’s useful, and he doesn’t come home with you at the end of the day.
Bob has two jobs. The first is to hold the business’s money, and other assets, and so all the money and equipment you use in your business will be held in Bob’s name. But the second job is more important: Bob takes the blame. If you do anything wrong while you are operating your business, Bob gets sued, not you; and if Bob loses, Bob pays the judgment. Like a good boss, he protects his employees by taking the bullet.
An LLC is much like a regular corporation such as GM or Google, but smaller and simpler. In order to form a corporation, the owners have to go through some pretty elaborate paperwork as well as obey complicated rules and pay special taxes, and for this reason, corporations are usually much larger affairs than a simple LLC - an imaginary boss to hundreds or thousands of people, rather than just a few.
Starting up an LLC is simple, just sign some paperwork and Bob is ready to work. However, Bob can only do his job if you take him seriously. If you don’t genuinely act like Bob is real - by rigidly separating the LLC’s assets from your own and following corporate formalities - then when Bob gets sued, the judge might just decide that Bob isn’t real enough to catch a bullet, and your assets will be on the line. LLCs are a powerful protection, but you have to follow their rules if you want their help.
Last, remember always that LLCs have special taxation rules. Once you form an LLC to protect your business, don’t be shy about talking to a certified public accountant to make sure that Bob is paying his taxes - Bob certainly won’t pay them without your help, because, being a legal fiction, he doesn’t have hands.