When you open a business, you decide what business structure you want to have. And, that decision determines what the legal requirements are for your company. But, is your business a separate legal entity (SLE)? And, what is a separate legal entity?
What is a separate legal entity of a company?
So, what is the meaning of separate legal entity? A separate legal entity is when you and anyone involved in your company are separate from your business for legal purposes. Basically, an SLE means that if someone takes legal action against your business, your personal finances are separate and safe from the legal suit. And, any investors, stakeholders, shareholders, and partners are also personally protected.
But, only certain business structures are legally separate from personal assets, including:
- C corporations
- S corporations
- Limited liability companies (LLCs)
- Limited partnerships
If your business is an SLE, you have personal liability protection. Examples of personal protection include:
- Individuals or businesses cannot hold shareholders liable for the business’s actions
- Separation of business and personal accounting and assets
- Creditors cannot seek repayment from or take action against shareholders
Benefits of a separate legal entity
So, why is a separate legal entity important? In addition to personal protection from being held personally liable in legal proceedings, being a separate legal entity has some other benefits. When a business is a separate legal entity, it has its own rights under the law.
A business organized as a separate legal entity is a structure able to:
- Enter into contracts
- Own property
- Start legal proceedings against another entity
What is a separate entity?
Now that you know what a separate legal entity is, you may be asking, What is a separate entity? Great question! All businesses should be separate entities from the owners, members, stakeholders, etc. of the company. A separate entity just means that the business keeps its finances separate from the personal assets of anyone with a stake in the company.
When you start your business, you should create separate:
- Bank accounts
- Credit card accounts
- Tax identification numbers (TINs)
But, your business being a separate entity does not necessarily legally protect your personal assets in the event of lawsuits against your business. There are two business types that are separate entities but are not separate legal entities:
- Sole proprietorships
- Partnerships*
*Generally, federal law does not separate partnerships from individuals. However, many states have adopted laws that legally separate partnerships from the partners’ personal assets. So depending on the type of partnership, one, some, none, or all of the partners may be personally and legally liable for any lawsuits brought against the partnership. Check your state laws regarding the legal liabilities for your type of partnership.
Partnerships as separate legal entities
There are several types of partnerships, and the legal liabilities of the partnership depend on the type your business chooses. Here are the types of partnerships and their liabilities:
- General partnership: All partners share equal legal and financial responsibility for the business. Written agreements may determine the amount of each partner’s responsibility.
- Limited liability partnership: Limits the personal liability of each member so that if one member is sought out in a lawsuit it does not affect the other partners. This type of partnership reduces the risk for uninvolved parties to any disputes.
- Limited partnership: Combines both general and limited liability partnerships. At least one member is legally and personally liable for the business and its debts. One or more members of the partnership are silent partners whose liability is limited to the amount of their investment in the business. Typically, silent partners do not participate in the day-to-day operations of the business.
- LLC partnership: As a multi-member LLC, LLC partnerships are legally treated as LLCs.
Again, state laws may determine the true legal liability for the partners and separate partnerships as SLEs from the partners themselves.
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How does being a separate legal entity help business owners?
When your business is separate from your personal assets, you are legally protected from individuals or companies receiving personal assets in judgments against your business. Legal protections can save you from:
- Creditors seizing your assets to pay off your debts
- Personal liability lawsuits
- Personal bankruptcy
- Selling personal property or other assets to pay for lawsuits
Let’s look at a few separate legal entity example scenarios and how SLEs can help a business.
Example 1
You are a sole proprietor running a small bakery. As the only employee and owner, you have the personal legal responsibility for everything involved in running your business.
Your business is growing, so you take out a loan to purchase equipment. Because your business is a sole proprietorship, the lender may seize personal assets, such as your car or home, if you fail to repay the loan.
Bonus example! Say you have a customer who comes into your business and gets an injury. The customer may choose to sue your business for any injuries they get at your business. As a sole proprietor, the court may require you to sell personal assets to cover the costs associated with the lawsuit if you are found liable.
Example 2
Let’s say you are in a partnership and you are a silent partner (i.e., limited partnership) with a 25% stake in the business. The company manufactures electronics, and the company faces a lawsuit.
Your personal liability in the lawsuit is limited to the amount of your investment, 25%. Your partner carries 75% of the liability in the lawsuit and may have assets seized to pay for it. Or, your partner may need to use personal funds to cover the costs of the legal proceedings.
If the lawsuit costs $25,000, your stake consists of $6,250 toward the legal proceedings ($25,000 X 25%).
Example 3
Your business is an S corporation that provides dog grooming services. Your business decides to purchase a new building and a company van for mobile grooming. As an S corporation, your business can legally purchase property under the business’s information. You do not have to purchase the property under your personal information.
Instead, you can begin the property purchase process using your business’s name, TIN, and banking information. When you finalize the paperwork, the deed to the property is under the business’s name.
This is not intended as legal advice; for more information, please click here.