When an owner calls us at Delancey Street behind on a merchant cash advance or a bank loan, one of the first questions is: can they come after me personally? The other question that we hear from owners is ‘What’s my risk?’ In other words, what could I lose, if I can be held personally liable. The answer to both depends on two things. The first is how your business is structured. The second is whether or not you signed the loan documents as a personal guarantor. And it is a common practice for many lenders to require a personal guarantee, regardless of the structure. That doesn’t mean it doesn’t matter what structure the business is in.
Without Organizing a Legal Entity
If you are the only owner and you never organized as a corporation or an LLC, you are doing business as a sole proprietorship. In that case, whatever debts you owe as a business owner are considered your personal debts, and creditors can come after you personally. The debts of your business are your personal debts, and if the business can’t pay its debts, it will be up to you to do so. There is no legal protection separating you from your business.
You can think of a general partnership as a collection of sole proprietors. In a general partnership, you and a number of other people have decided to do business together without organizing a legal entity. Every partner is liable for all of the debts, not just a proportionate share. If a third party sues one of the partners in a general partnership and wins, they can come after that person’s personal property. This means that one partner can be held responsible for the business debts of another partner. A limited partnership has one general partner and one or more limited partners. The general partner, however, has unlimited personal liability for business debts. The limited partners are not. Depending on your state, you may also be able to organize as a limited liability partnership. In an LLP, all of the partners are protected from personal liability.
A Separate Legal Entity from Their Owners
With a corporation, shareholders are not liable for the debts of the corporation. Corporations exist as a separate legal entity from their owners, who are known as shareholders. If you filed with the state as a corporation, that is what you have, and creditors may only come after the corporation’s assets. But there are situations in which they can collect from the shareholders anyway. The first is the personal guarantee. If you have personally guaranteed a debt, you will be held liable, and the same goes for cosigning. A personal guarantee simply means that the owner is taking personal responsibility for paying a debt. That means that if a business doesn’t pay, the owner is on the hook.
The other route is piercing the corporate veil. If a court pierces the corporate veil, that means the shareholder(s) can be held personally liable for the debts of the corporation. This can happen in several ways. One is failing to obey corporate formalities. It’s a fancy way of saying things the law says that a corporation must do. Think holding meetings of the board of directors, or holding annual elections for directors. Another is commingling of funds. Commingling of funds means mixing the funds of the corporation with the personal funds of a shareholder. If you use corporate funds for personal expenses, and vice versa, it’s a red flag for piercing the corporate veil. The third is fraud. A court may also pierce the corporate veil if there is fraud involved. Fraud can include any falsification on a business loan application.
With a limited liability company, the owners, known as members, are not liable for the debts of the LLC. If you are a member of an LLC, you stand to lose whatever you put in to your business. The LLC’s assets alone can be used to satisfy a business debt. As with a corporation, there are ways that creditors can come after the members. An owner may be liable under a personal guarantee, too. Creditors may also be able to pierce the LLC veil. If you do violate your legal requirements as an owner or commit fraud, you can be held personally liable.
With a sole proprietorship, the business debts are your debts. With a general partnership, each partner is liable for all of the debts. In a limited partnership, only the general partner is personally liable. With a limited liability partnership, no one is personally liable, but only if your state recognizes it. With a corporation or an LLC, your personal assets are generally protected, except that you can be liable if you personally guarantee the debt or if the creditor succeeds in piercing the corporate veil. If you own a business, take a look at your business entity and your loan documents. Above all, you, as an owner, need to know the difference between signing as a business owner and signing as a personal guarantor. It’s important to know so that you understand how you stand. Take the time to review the documents, and if you don’t know, ask. If you have concerns, speak with an attorney.
At Delancey Street, we are not a law firm. When litigation or bankruptcy are the appropriate solutions, we will refer owners to a vetted independent attorney. What we do is negotiate with funders and lenders for less than the full balance owed, and the first consultation is free and confidential. If your small business is facing financial distress and a repayment of either a merchant cash advance or a bank loan, please call us so we can discuss how we can help you through this challenging time.
