Avoiding the Risks of a Single Member LLC
Forming a single member limited liability company can be a great way for business owners to avoid personal liability for the debts and liabilities of the company. However, being the single member in a single member LLC carries with it an enhanced risk of personal liability by creditors piercing the corporate veil and the alter ego doctrine. If the assets and the actions of the LLC are so intertwined that the LLC is merely the “alter ego” of the business owner, creditors may be able to pierce the corporate veil and go after the personal assets of the business owner to satisfy debts of the company.
While there is no guarantee that your personal assets will be protected from liability, here are a few things that you can do to attempt to avoid a creditor being able to pierce the corporate veil:
- Follow legal formalities: even in a single member LLC, the LLC still needs to keep records and meeting minutes, and follow a well-drafted operating agreement. Here is a Sample Operating Agreement for a Colorado Single Member LLC. Editor’s Note: I debated with myself a lot about if I should put up a sample single member LLC operating agreement. While I feared that many of you would abuse it by simply filling in your name and business information, without seriously considering the other terms, I did it anyway. It’s not like this was the only sample operating agreement you would find; the internet is full of them. But please note that I strongly recommend that you not take it upon yourself to create your operating agreement without the advice or guidance of an attorney.
- Adequate capitalization: under-capitalizing an LLC is a sure-fire way to open yourself up to personal liability. If you don’t generally keep enough money in the business to pay the regular overhead and operating expenses, for example, a court may see that as you intentionally (and fraudulently) under-funding the LLC in an attempt to make it judgement-proof (“So what if they sue the company? The LLC doesn’t have any money, anyway!”).
- Never commingle funds: EVER! Business money pays business expenses and personal money pays personal expenses. Many people will need to use their own money or savings to start their business. When you do that, you need to first deposit that money into your dedicated business account, then you can pay those business expenses from the business account. You can give your own money to your business, usually as a loan or a capital contribution, but you should not just whip out your personal debit card all willy-nilly to pay for office supplies. And you can’t go writing company checks to pay your mortgage, either. Make sure you pay yourself as an ownership withdrawal, or as a salary if the LLC is taxed as an S Corporation, first.
- Always act on behalf of the LLC: when you sign documents on behalf of the LLC, make sure you are signing documents ON BEHALF OF THE LLC. For example, I would sign paperwork as “The Law Office of Aiden H. Kramer, LLC, By: Aiden Kramer, Member.” I am not signing in my personal capacity. In some instances when you are starting a new business, for example if you are applying for a business loan or are leasing a commercial property, you may be required to personally guarantee the loan or lease. In those cases you would need to sign the document both on behalf of the LLC and in your personal capacity.
This is not meant to be an exhaustive explanation of the factors that go in to piercing the veil of the single member LLC. These are just some of the important steps that need to be taken to attempt to avoid personal liability in a single member LLC. If you have any concerns about whether or not you are doing it right, you should seek the advice of a qualified attorney.
And while I don’t recommend it, if you insist on forming a single member LLC yourself, you can read my handy-dandy Do-It-Yourself Guide to Forming an LLC in Colorado.
Denver, Colorado business attorney Aiden H. Kramer can help you make sure you are avoiding the risks of a single member LLC. Contact Aiden Kramer at (720) 379-3425 or [email protected].
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