Many of those who want to start their own business do so just by starting to sell products or offer their services. This works well for many small businesses but acquiring debt can be a huge downside and liability for the business owner. Instead of operating under a sole proprietorship, which is the default business type, small business owners may want to form a corporation to limit their liabilities and protect their personal assets. So how does forming a corporation protect a small business owner’s assets?

Debts Without Forming a Corporation

When a business owner does not file to form a corporation or other type of business, their business is considered a sole proprietorship. With this business type, the business owner is fully liable for anything the business does. What this means is that when there are debts owed and they cannot be paid by the business, the business owner is personally liable for the debts.

What Happens to Assets?

If there is no protection for the business owner, creditors can go after the owner’s personal assets to cover debts the business owes. If the business owes money and cannot repay those funds, the creditor could put a lien on the business owner’s bank accounts, their home, or their vehicle until the debts are repaid. If the debts are still not repaid, it’s possible for the creditor to take ownership of the assets and sell them to get the funds.

Forming a Corporation

A corporation is a type of business that offers limited liability to business owners. The shareholders who run the business are not personally liable for any debts the corporation may have. This protects the business owners or shareholders from having to pay off debts owed by the business in most cases.

Debts After Forming a Corporation

If the corporation does owe debts, the creditors can only go after the assets owned by the corporation. That means the assets owned by the business owners or shareholders are off-limits. There are certain exceptions to this, such as if a shareholder personally guarantees the corporation’s debts, but as long as the business owner is careful, their assets should be safe.

While no one expects anything to go wrong, there is a lot on the line if a business owner ends up owing money to creditors and the business cannot pay those debts. Instead, business owners who are interested in protecting their personal assets from any potential debt the business may have will want to investigate forming a corporation.