There are four major single member LLC mistakes that plague every online business owner. In today’s post, you will learn how to avoid the four risks that are inherent with every single member LLC.
What is a Single Member LLC?
Before we get into the four things that you can do to avoid the risks that are inherent in every single member LLC, it is important to discuss what a Single Member LLC is. We call it a single member LLC because when you're talking about an LLC, the person owns the LLC is called a member. So that's different than a corporation where the person that owns the corporation is a shareholder. So you might own stock in a corporation but when you're talking about an LLC, if you own the LLC what you own is a membership interest. And if you are the only person that owns the LLC, you are the sole member or the single member owner of that LLC. So a single member LLCs are different from multi-member LLCs where there will be a number of different owners. And there's a whole different set of problems that come along if you do have a single member LLC and that's what I want to talk to you about today.
Now, the reason all this is important is because when you have a single member LLC a lot of the reasons that most people form a single member LLC is because they want some level of liability protection. In other words, if their business does something that causes them to get sued then they want to make sure that the person that's suing the business can't come after their personal assets. When somebody does that and they're able to sue the LLC and they go through and sue the owners of the business as well and they're able to get at those personal assets, that's called piercing the corporate veil. You do not want that to happen. And there are four primary ways that that can happen.
Single Member LLC Mistake #1 – Not Following the Appropriate Legal Formalities
The first thing to do when you're a single member LLC to protect yourself is make sure that you follow all the appropriate proper legal formalities that are required to operate and own a LLC. So this is going to be, you want to do the same things for a single member, LLC that you would do if there were multiple owners and it was a multi-member LLC or if it was an even bigger business than that. The biggest most important thing you're going to do is you're going to want to have what's called an operating agreement.
An operating agreement is an agreement between you as a member or owner of the LLC and the LLC to make sure that the LLC is run in certain ways. And that means that it talks about how you're going to take a salary. It might talk about how you're going to choose to buy property for the LLC, the type of business that you're going to be engaged in, the type of insurance that might be required, where the business is going to be located. What happens if you decide to dissolve the business, how much money you're going to contribute to the business to make sure it's adequately capitalized. All these things go into the operating agreement.
So I know what you're thinking about these operating agreements. You're thinking, well that is all well and good but why do I need to do that if it's just me, if I am the only owner of the business, why do I need you to have a contract with myself about what I'm supposed to do and how I'm supposed to run the business? This is why I'm in business for myself. I want to be able to do my business the way I want to do it and I don't want to be bound by all these legal formalities. Well, okay, but if you want to protect yourself against potential legal liability, if you want to protect yourself against somebody suing you and getting at your personal assets, then you need to follow these legal formalities. That's all I can tell you.
So the operating agreement is a big one that you're going to need to do. Another legal formality is to make sure you keep track of key decisions that are made in the business. And you do that with meeting minutes. So you're going to have regular meetings of the members. In this case, it's going to be you and you and you're just going to have a meeting with yourself. And let's say you decide that you want to buy a brand new laptop for the business. Well, then you're going to have a meeting with yourself and you're going to say today we had a meeting of the members of the LLC and we be it resolved that we decided to purchase a new Apple Airbook. And the cost of this is going to be $2,000 and we're going to use the firm or the business credit card to purchase this equipment and pay for it out of the profits of the LLC or something like that.
You write that all down, you include it in a notebook or an online file that you have that's got all this information handy. That's another legal formality. The heater just popped on. I'm going to turn that so it doesn't make noise. So another thing that you're going to need to make sure you keep good record of to make sure that you adhere to all these legal formalities is you need to make sure that you have good tax records in place for the LLC. So you're going to want to make sure in all likelihood you'll want to hire a bookkeeper who can make sure that you've got your accounting set up correctly, and that you keep track of everything correctly that way. And you want to make sure you have good records in place so that when it comes time to do your taxes that you've got a clear delineation of what was done for the business and what was not done for the business.
So along those lines, another thing that's really important is you need to make sure that you have separate bank accounts. A bank account for you personally and a bank account for the LLC. So this is again very important to make sure that you don't violate what's called the alter ego doctrine which basically is a doctrine that says that you are basically the same as your business. And if you are the same as your business then that's going to be problematic. And that's a way that somebody can come in and pierce the corporate veil. So if you just use the LLC as your personal bank account or let's say you set up the LLC, you file all the paperwork so you've got an LLC and then you just deposit everything from the LLC into your personal bank account, that's a problem. You need to set up a separate bank account with a separate EIN for the LLC. All the income from the LLC goes to that.
If you want to take a capital draw, here is a link to another video explaining how to pay yourself out of the LLC. It's a fairly simple process but it's going to depend in large part on whether or not you like the S-corporation status. That's another video, which I'll probably put up here as well. So that's another thing to consider. You want to make sure that you have a separate bank account for the LLC and yourself personally. If you want to take money out of the LLC, that's fine, pay yourself out of the LLC. Or if you need to put money into the LLC to pay bills then you make a capital contribution or a loan to the business to pay your bills and then you do it that way. But make sure you have the two separate bank accounts.
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So that was a long way to say the first thing which is to make sure that follow the appropriate legal formalities for your business so that nobody can pierce the corporate veil that way.
Single Member LLC Mistake #2 – Not Adequately Capitalizing Your Business
The number two tip I have for you on how to avoid liability with your business is to make sure your business is adequately capitalized. So what I mean by that is when you get money into the business, you want to keep it in the business to pay the operating expenses of the business. If you get money in the business and you immediately take it out and put it into your own personal bank account and you think, Oh, well now they can't get at that money, that's a problem because they could technically get that money. If your business is not properly capitalized to pay for the expenses related to that business, if it's under-capitalized, then that is a reason why somebody would be able to come in and pierce the corporate veil so that's number two.
LLC Mistake #3 – Co-mingling Business and Personal Finances
Number three is to avoid co-mingling personal and business funds. We already kind of talked about that. This is the alter ego doctrine again. Just you need to make sure you have two separate bank accounts, one for the business, one for your personal. We already talked about that. I'm not going to dig too much into that right now.
LLC Mistake #4 – Not Holding Yourself Out as the Owner of the LLC
Number four is a big one. This is something that a lot of people mess up quite a bit, and you need to be very careful of. And that's that you need to act as the owner of the LLC. So I've got this brand new, it's not new, but I've got this beautiful new office condo that I just leased in the name of my law firm to house my law firm. It's great. We've got six offices. We've got a lot of room, a lot of space. When I signed the lease agreement, I signed it as the president of the Hart Law Firm, which is the name of my law firm. This is the Hawthorn Law. I'm doing businesses as Hawthorn Law. The name of the business or the name of my parent company is the Hart Law Firm. And I signed the lease as the president of the Hart Law Firm.
Any time you enter into a contract, whether it be with somebody as an independent contractor or an employee or whether you're doing work for somebody on a consulting basis or something like that, anything you might do where you have to enter into a contract where your business has to enter into a contract business is the entity that needs to sign the contract. And you will basically sign it as the name of the LLC by your name as owner or member or whatever it might be. I'm a president of my corporation because my law firm is formed as a professional association which is a type of corporate entity. It is not formed as an LLC. But if I were an LLC, I'd be owner or member or something like that.
Final Thoughts on the Mistakes People Make with their Single Member LLC
All right, so there you go. Four things that you need to think about when you are forming your single member LLC to make sure that nobody can sue you and get at your personal funds. And let's just run through them again. Number one, you need to follow all the proper legal formalities. Number two, you need to make sure your business is adequately capitalized. Number three, you need to avoid commingling funds. And number four, you need to make sure you act in your capacity as owner or member of the LLC whenever you're doing business with somebody else and you're signing contracts. Those are the four things you need to know.