What is a Limited Liability Company?

What is a limited liability company, or what is an LLC? Well, the answer to this question is simple in some respects and confusing in other respects. Practically speaking, a limited liability company resembles a corporation in that an LLC is a separate legal entity often used for operating businesses or holding investments. The limited liability company or LLC can own property, make contracts, and do many of the sorts of things a real human being can do.

More technically, a limited liability company or LLC is created when you step through the llc formation process by filing paperwork with and paying fees to a state agency (usually the secretary of state for a state). For example, a California business or investor might create a California limited liability company by filing paperwork with and paying a fee to the California Secretary of State. If the California secretary of state accepts the paperwork, by act of law, the LLC is created.

I'm going to talk in more detail in the following paragraphs about why you might choose to form a limited liability company, but let me make one other general comment about the question, "What is a limited liability company?"... In some respects an LLC is a "product" or "service" that states (California, Texas, Florida and so on) sell to businesses and investors so the business owners and investors can limit their legal liability. People usually don't think about a limited liability company or LLC in this way, but especially for small business owners, this view of llc incorporation is useful.

A simple example can show you how powerful this "limiting" of the liability can be. Suppose two entrepreneurs, Jack and Jill, each operate a construction business. Jack operates as a sole proprietorship. Jill operates as an LLC. Further suppose that an angry customer sues both contractors. Maybe some project has gone horribly wrong. The customer suing Jack's proprietorship can look both to the proprietorship (the business) and the proprietor (Jack) for damages. If the business breaches its construction contract with the customer and that breach results in the customer suffering economic damages, the customer can sue the business. And the customer can sue Jack.

The customer suing Jill's limited liability company doesn't have quite the same set of options. If Jill's construction company breaches its construction contract with the customer and that breach economically damages the customer in same way, the customer can sue the business. But the customer can't sue Jill just because she's the owner.

1. Even if Jill does operate her business as a limited liability company, she may end up contracting with customers and vendors in a way that wipes out the benefit of the limited liability company. For example, Jill might offer vendors (like the bank) or might offer customers a personal guarantee. In other words, while state law would normally limit Jill's legal liability, Jill might agree to bear legal liability through something like a personal guarantee.

2. If Jill works in the construction company, she may have liability based not on her ownership but on her personal involvement. For example, if Jill herself does some particularly shoddy construction and then, at some later date, the customer's children are seriously injured as a result of the shoddy construction, Jill almost certainly bears financial responsibility in this case. Note, though, that this would be true for any worker. If you or I work in construction and through our own negligence create a really dangerous situation--we build a deck that collapses when someone walk on it--we almost certainly bear liability. (Darn it, we should if you think about it for a minute.)