Let's say you run a small photography business, taking pictures of babies for excited, proud parents. You've heard that you should incorporate or form an LLC to limit your liability.
But what does that actually mean?
Not what you think it does.
What an LLC does
It turns out an LLC protects you, the owner, from your business's financial liabilities. Going back to our photography business example, let's say you want to buy some better lenses for your camera that will let you take even more adorable photos. You convince a bank to give your business a loan without a personal guarantee from you (see note below), and you buy your equipment.
Two years later, your business runs out of cash and has to shut down. You can't pay the bank anymore, so they foreclose on the loan and force you to sell your camera equipment to settle the debt. Because your limited liability company is the only party to the loan, the bank can't make you sell your house or your car or dip into your retirement savings.
Another example, let's say a family sues you because they feel you overcharged and delivered a shoddy product. If they were to win, your business would need to pay the judgment, but you would not personally have to sell your car. You could let the business burn down instead.
Note: no bank in the world will lend your small business a loan without a personal guarantee from you. This means that you and your business are co-signing the loan, which puts you on the hook.
What an LLC does not do
Let's imagine the worst case scenario. You're shooting pictures of a new baby and their family in your house, when suddenly a freak accident happens, a light falls over on top of the baby, killing them instantly.
Does your LLC protect you, your family, and your business from the inevitable fallout?
NO, it does not.
The family and their insurance company can and will come after you, personally, as well as your business, for every single cent you have. If you don't have the right amount of insurance you will be devastated not only emotionally but financially.
So what's the right arrangement?
In every business you need to assess your risk, both personally and professionally, and find solutions that protect you. For the above situation, you should likely have a professional liability policy and a personal umbrella policy on top of your homeowner's policy. You should talk to an insurance broker so they can guide you to the coverage you need.
Want to know more?
My book Handle Your Business will teach you everything you need to know about running your small professional business. From insurance to incorporation to taxes to contracts, this short guide helps you run your business better.