If you’re a small business owner and do business on credit, it’s crucial that you know your customer. It’s even more important if the customer is a limited liability company (LLC) or corporation.
LLCs and corporations are separate legal entities under the laws of all states. That means they can buy and sell goods and services, sue and be sued, carry on business, and extend and receive credit, all in their own names. If you, as a business owner, sell something on credit to an LLC and the LLC doesn’t pay, where do you turn to collect? In most cases, the only recourse you have is against the customer, the LLC. If the LLC suddenly ceases business and closes its doors, you could be left with no goods and no way to collect the debt. Sure, you can sue, but nine times out of ten, that LLC had no assets to begin with, or what it had was fully encumbered by a bank.
As a small business owner extending credit, it’s up to you to protect yourself before something happens. There are a number of ways you can increase the odds of being paid if the customer suddenly goes belly-up.
First, know who your customer is. Whether the “customer” is an LLC, a corporation, a partnership or some other entity, you’re dealing with a person. First, find out what authority that person has to act for the LLC. Is she a member (owner) or manager? Is she an employee? If so, does she have the ability to bind the LLC?
Next, is the LLC legitimate? LLCs are simple to create. In Utah you can form one online for about $50. Make sure the LLC you’re going to do business with actually exists. You can do an online business entity search in Utah here. Enter the name you’ve been given to see if the LLC or corporation exists, whether it is current, and how long it’s been in business. Sometimes you’ll find several LLCs with similar names. I once had a case where my client was dealing with a business that used “Sahara” as part of its name. It turned out that the principal of the business, the guy my client thought it was really dealing with, had over a half-dozen businesses using the word “Sahara” as part of its name. It was almost impossible to figure out which Sahara entity had made the contract with my client. If you find something similar, make sure the name of the LLC you’re dealing with matches the name on file with the state.
Now, just because a business entity exists, is current and matches the name of the entity you want to deal with doesn’t mean it has any assets. There’s simply no way to know whether that LLC is good for the debt. You can really increase the odds of being paid by getting a personal guaranty from the principals of the business. A personal guaranty is a promise by an individual to pay the debts of another.
In a later post, we’ll talk about what legal documents you need to help you protect yourself if you routinely extend credit in your business.