We got this email from one of our subscribers.

Dear Profit and Laws:
I own a car wash, but I just have it in my name and haven’t set up an entity. Do I really need one? Thanks. My boyfriend and I love your blog,
S.K. from Gary, Indiana

Dear S.K. You absolutely need an entity. Here’s why.

An “entity” is an invisible box that holds your business. It is like a Kevlar suit for your company – it gives you a professional appearance and a chance at safety from bullets. That is because many (though not all) entities give you limited liability.

Limited Liability. “Limited Liability” is a shield protecting owners of a company from liability beyond what they have invested.  Without limited liability, you are personally on the hook for your business’s debts. With limited liability, you don’t have your house and college funds on the line every time you make a decision.  (Limited liability does not protect against liability for crimes, harassment, securities violations, failure to pay your employees’ withholding to the IRS, fraud or environmental liability. It also doesn’t protect you if you pull all your money out of your company to avoid business creditors.)

Kinds of Entities. There are just a few kinds of entities. The major entities are in the picture, in order of limited liability protection. Limited liability only comes with entities that you have to set up with a state government – corporations, limited liability companies (“LLC”), and limited partnerships (“LP”). This protection is regarded as a privilege and an incentive for business people, because it encourages them to invest in businesses without risking everything.

Imagine. S.K., to understand why you need an entity, imagine…

A giant Hummer drives in for a car wash. The owner of the Hummer has the nerve to ask your employee for a different kind of (ahem) hummer.  So, during the drying off phase, your employee climbs up into the Hummer with Windex, a rag, and a box cutter, which she uses to shred the seats. The owner and requestor of the Hummer and hummer sues your business. The lawsuit will cost $20,000+ in legal fees and Mr. Hummer will probably win $20,000+ for new seats. Because it was an intentional act of your employee, your insurance may not cover it. So, that means the $40,000 in bills will hit your business. If you just continue to operate your car wash in a sole proprietorship or partnership, the liability doesn’t stop at your company – it falls onto you – you are personally on the hook for it, as if you were the one who shredded the seats. But, if you have an entity, the $40,000 stays wrapped inside the bubble – you may lose the business, but not your house.

I hope that answers your question. Next week, I’ll answer questions about entities and how to pick the right one for you.