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Undercapitalization may be a problem for your LLC

On Behalf of | Mar 30, 2020 | Business Law |

If you are looking for personal gratification, professional success and financial security, starting a business may be high on your priority list. After all, not only is providing in-demand goods or services important to the modern economy, but it is also an effective way to live the American dream. Still, if you intend to form a limited liability company, you must be sure you have adequate capitalization.

Setting up an LLC for your business venture may make a great deal of sense for a variety of reasons. Perhaps most importantly, LLCs shield their owners from personal liability for the company’s actions. As such, even if your LLC fails, you do not have to worry about losing your house, cars or other assets. Still, this protection is not absolute. If your LLC’s creditors can pierce the veil, they may be able to gain access to your personal wealth.

Reasons for piercing the veil

In business law, “piercing the veil” means getting through organizational safeguards to hold owners personally liable for company actions and liabilities. Creditors who choose to go this route have some options. Here are a few common reasons for piercing the LLC’s veil:

  • Committing fraud
  • Commingling personal and LLC assets
  • Disregarding LLC formalities or obligations
  • Insufficiently capitalizing the LLC

The importance of adequate capitalization

Starting a business venture often takes a considerable amount of time and energy. Because creditors can use the LLC’s undercapitalization as a reason to attack your personal assets, though, you must also be careful to secure sufficient funds. There are no official guidelines about what constitutes adequate capitalization, unfortunately. As such, you likely want to draft a comprehensive business plan that includes both expense and income projections.

If you have a brilliant business idea, you may be itching to get started as quickly as possible. You do not, however, want to risk your personal assets. By understanding how undercapitalization may allow your creditors to pierce the LLC veil, you can better plan for both meeting customer demands and protecting your individual wealth.