What is Limited Liability?
Catherine was a great baker. She sent all kinds of treats into school with her kids and to her spouse’s office. Her friends convinced her to start a bakery business out of her home. She branched out into catering. Eventually, things got so busy she hired some employees who could deliver food to various events for her.
One day, her driver, Daniel, got stuck in traffic in July and the A/C in his truck was out. Long story short, the potato salad went bad, and a bunch of people got sick. They sent Catherine their medical bills and demanded she pay their lost wages from being out of work. The host of the catered party demanded a total refund of the fees.
Because Catherine had started out of her home as a sole proprietor, she never really set up her business as a business. There was no entity, no contracts that limited her financial exposure and no insurance policy. She had to refund all that money and pay all those bills personally. She ended up draining her bank account and having to liquidate her IRA to satisfy the debts.
This is an example of personal liability.
If, however, Catherine had formed an LLC (or a corporation) when she started her business, she would have had limited liability for the bad potato salad. The injured people would have been limited to the assets of the company (including its insurance coverage) provided Catherine was properly formed and keeping up with her annual reports with the Secretary of State.