The most common business structure is the sole proprietorship. Yet, I usually recommend that entrepreneurs form a Limited Liability Company (LLC) or corporation  (C-Corporations or S-Corporations). Perhaps the most important of the many benefits of an LLC or corporation for the entrepreneur is the limited liability protection.

LLCs and corporations are distinct and separate entities from the entrepreneur, but a sole proprietorship is not separate from the business owner. That is, the business and the owner are considered a single entity. So, if a lawsuit were to be filed due to a business action, the LLC or corporation is the party sued, not the entrepreneur. In the case of a sole proprietorship, the entrepreneur would be the party sued and the personal assets of the entrepreneur - the house, the car and other assets - can be at risk.

The limited liability protection that an LLC and a corporation provide is important because it can shield the entrepreneur's personal assets from lawsuits arising from business activities (since the LLC or corporation is sued, not the entrepreneur personally). Lawsuits can occur if, for example, the business cannot pay its suppliers or creditors, someone slips and falls, etc. 

Despite the advantages of limited liability after forming an LLC or corporation, entrepreneurs often do things that cause them to lose the liability shield and, therefore, become personally liable for corporate actions. Two of these actions are signing personal guarantees and combining personal with business actions.

Signing Personal Guarantees - Entrepreneurs who borrow money from banks and/or lease their facilities are normally asked to sign personal guarantees even if he or she has formed an LLC or corporation. A personal guarantee means that if the business defaults on an obligation, the entrepreneur is liable for that obligation. A bank typically requires a business owner, especially if it's a new business, to be personally responsible for repaying the loan if the business cannot pay it back. This puts the business owners' personal assets at risk as the bank will go after those assets in the event of a default. 

So, be aware that if you sign a personal guarantee, it eliminates the limited liability protection afforded by an LLC or corporation for whatever you guaranteed. However, most banks will not lend the business money without getting a personal guarantee in return. Like it or not, their rationale is that if the entrepreneur does not have the confidence to stand behind his or her business, then they won't either.

Combining Personal with Business Actions - When forming an LLC or corporation, the business owner is a separate entity from the business so all business activities should be kept separate from personal activities. Entrepreneurs who do not have distinct business vs. personal activities blur the lines and can be considered as one entity even if they have formed an LLC or corporation. Thus, their personal assets can be liable.

For example, the business should have a separate bank account that all business expenses should be paid from and all business income should go into. Money that the owner (and others) contributes to the business should also go into the separate business account. Entrepreneurs must be very careful not to pay personal bills, such as the mortgage, out of the business account.

Do not deposit business revenue into the personal account.  Entrepreneurs must be very careful to demonstrate that the business is separate from the person. When personal assets are combined with business assets, the lines between the two are blurred and will subject the entrepreneur to potential liability that can otherwise be avoided.

If just to shield you from potential business liabilities, a separate business entity such as an LLC or corporation is superior to a sole proprietorship. However, you will not be shielded in every circumstance. Understanding what actions can cause you to be personally liable for your business' activity is critical.

Greg Henley is the Director of the Herman J. Russell, Sr. Center for Entrepreneurship at Georgia State University. His background includes entrepreneurial experience both as a practitioner and as an academic. Dr. Henley received his doctorate is from Columbia Business School with a concentration in Strategic Management and Entrepreneurship.