As a sole proprietor who has recently survived a Chapter 7 bankruptcy, I have experienced the worst possible scenario, but not the worst outcome. While my LLC counterparts struggled to keep their businesses, I had the benefit of undergoing a personal bankruptcy that also extended to the business, a sole proprietorship. This allowed me to continue working on my art and selling it at my small shop.

For the wealthy, the LLC, or Limited Liability Company, is the standard advice because if a business becomes overleveraged, it protects things like a house and car from being repossessed to settle the business debt. But for those with no real assets, or for creative types, it can act like an anchor that sets them up for failure. While I am in no position to offer any legal advice, I do think it is valuable to consider these points before giving or receiving any advice about an LLC specifically for creative passions.

The Pros and Cons of an LLC for Artists

The LLC is basically a lockbox for your business. It creates a corporate veil, or a separation between you and your business. If you take a risk in your business and fail, the business is in a lockbox. A Chapter 7 (liquidation) is the cheapest and easiest bankruptcy. If you cannot afford a Chapter 11 (reorganization), it may be the only option you have. In the case of an LLC in Chapter 7, the lockbox is sold. You allow the courts to liquidate the lockbox and walk away with your life intact.

This lockbox only works when you need it to if you keep your finances and the finances of the LLC separate. If you mix them, you invalidate the protection. The LLC requires a lot of paperwork, expense, and organization. If you are struggling, this can be nearly impossible to do. Surviving financial hardship while self-employed means facing long days and the messy survival reality of the working class, but without collecting an actual paycheck. In my own struggling business, I know I have had to pay bills with whatever money I can scrape together, often combining bank accounts to avoid costly budget mistakes. If this is where you are in life, there is no shame in staying a sole proprietor.

For those who rely on their income from the business to pay bills, the lockbox becomes a dangerous paradox. While the lockbox can protect your wealth, it can also trap your income.

If you love your business, you likely invested in it more than your own wealth. Now, the only thing you own will be locked in the LLC. For artists, crafters, or other creatives, this means that your business assets will be liquidated. You may get out of the debt, but you will have no way to pay bills.

Consider Sole Proprietorship

Consider this: as a sole proprietor, you and the business are the same. You cannot file a business bankruptcy, but you do not need to. You can file a personal one, and unlike a business, a person is allowed exemptions, or things they are allowed to keep. Now, if you own buildings or many expensive things, this may not work. The key is to know that you have two options, federal and state. In the event that you live in a generous state, you may be surprised. When my commercial lease fell through, I was suddenly overleveraged. Within days, I went from having a viable, healthy business with employees to nothing but the tools of my trade and inventory.

What Happens If You File for Bankruptcy

I was always too busy to file that LLC, so my business was mine and I was the business. I could protect all my personal property, which included nothing more than my clothes, some used furniture, and a reasonably nice computer. A person in my state, New Mexico, is able to stack exemptions such as the tools of the trade exemption for $15,000, the wildcard of $15,000, and for sole proprietors that do not own a house, another $15,000 in lieu of homestead deduction. This $45,000, when framed by the yard-sale value of what a very small business is worth, is like winning the bankruptcy lottery.

I had to move what I could, and nothing was easy, but I got to keep making art, and that was everything. Now let’s consider how that may have played out with an LLC. In the case of an LLC, there are no exemptions. What physical items the owner gets to keep depends on this yard-sale value. Take, for instance, a candlemaker. The trustee (the person liquidating your estate) gets a tiny flat fee and a percentage of the property he or she sells. It’s not worth it to seize, store, and auction your melter, half-empty wax, or used molds. Without your labor and love, these supplies are nothing more than “used stuff.” The only thing in the LLC lockbox that won’t be sold is what gets abandoned, which might be everything simply because it has no immediate value.

Chapter 7 is not about saving your business; it’s about selling your assets.

If you have actual valuable business assets like machinery, a vehicle, a building, or anything that the trustee can make actual money on—all your efforts to elevate yourself will now be gone. You can start a new business. You can even use the abandoned property to do so, but if it is too similar to the bankrupt business, it may slip into the ghost of the lockbox, known as successor liability. In the case of this liability, what you make in the new business may be subject to a clawback because it can be argued that it belonged to the lockbox. Your brand is gone. You can still sell candles, but you will have to have a different business name and audience. All those connections and accounts you made can trigger a clawback. If you proceed, you do so precariously.

Keeping Control of Your Intellectual Property

For creative types, an LLC can lock up not only your income but royalties and other intellectual property. If you do have assets to protect, like your home, consider a tactic used by many large corporations called corporate entity splitting. You do not need to own onlyone business. You can roll your financial risk into a second business and file your LLC there. Take a candlemaker who loves making candles. If you love your specific way of making candles, keep that as a sole proprietor with no separate entity. When you grow and want to teach candle making, do not do it on your creative Schedule C. File an LLC for a school and do school things. Let other crafters teach there for a fee and charge your creative business that same fee. Write a check from one business to the other. The school has risks; it may not get paid for a large event. Then one day, should you be overleveraged, you will only lose that specific lockbox. In the most extreme failings, you will lose your school and any other LLCs, but you can still make your candles.

From a tax perspective, filing a single-member LLC while also being a sole proprietor can be very simple. You can file many Schedule C forms. Keeping the LLC accounts strictly intact will protect you and your life’s work, which will live as one in the sole proprietorship.

There’s No One Size Fits All Solution

A successful sole proprietor who actualizes economic prosperity can always form an LLC when protecting wealth becomes necessary. What’s damaging isn’t the LLC itself, which will keep the financially secure individual healthy. The problem is that it’s suggested for all businesses, and yours is unique. Take a few risks with your creative endeavors or roll those risks to a secondary business that may be profitable but that your heart can stand to lose.

If you have been told to form an LLC to defend against lawsuits like a slip and fall in your shop, or inadvertent libel in the case of, say, a writer, your better bet, regardless of entity type, is to get a good insurance policy like liability or malpractice. While an LLC could protect your personal assets in the case of an accident, it will not help in the case of negligence if you had a reasonable way to take action. It can keep your personal property safe if your partners or collaborators make a mistake, but if you make one, you may face personal liability. And it will not help at all if you break any laws. Having good insurance is one of the best proofs that you care about your responsibilities.

You can change entity types at any time. Just set up a long-term plan as a strategy; don’t panic-change in crisis, which can be problematic. Prepare for the worst and get familiar with bankruptcy exemptions, both federal and what may be offered in your state. There is a lot of LLC dogma out there that will pretend that the LLC is an egalitarian savior for all; it’s not. As a creator, you are the brand. This makes your business very different from a typical cold investment. Don’t put yourself or the crafts you love in a lockbox unless that’s really what works for you.

Candice Carnes

Contributor