Here is a recent question that came to our editor: What is your liability if your start fails after raising a venture capital fund?
Empirical data on startups indicate that a large percentage (between 70 to 90% ) of startups are doomed to fail. Some founders realize that they are captaining a sinking ship and bail out early and gracefully, others decide to do a Titanic by failing dramatically. Many others, however continue on a slow burn.
Let us look at the (failed) startup as a business venture. There are several
Sole Proprietorship – The business owner is personally liable for all debts incurred by the business.
- If you were running the startup as a “Sole Proprietorship” you could be liable for all the debts incurred.
General Partnership – Each partner shares the profits, losses, and management of the business, and each partner is personally and equally liable for debts of the partnership.
- If you were in a “General Partnership” with the VC, both of you will be equally liable for debts of the partnership.
Limited Partnership – The general partners manage the business and share fully in its profits and losses. Limited partners share in the profits of the business, but their losses are limited to the extent of their investment. Limited partners are usually not involved in the day-to-day operations of the business. Filing with the Washington Secretary of State is required.
- A VC may opt to be a “Limited partner” while the founder may be treated as a “general partner” who manage the business and share fully in its profits and losses.
Limited Liability Partnership (LLP)
A Limited Liability Partnership (LLP) is similar to a General Partnership except that normally a partner doesn’t have personal liability for the negligence of another partner. This business structure is used most by professionals, such as accountants and lawyers.
- Liability may be limited to investments made in the venture
Limited Liability Company (LLC) – A Limited Liability Company (LLC) is formed by 1 or more individuals or entities through a special written agreement.
- The agreement details the organization of the LLC, including provisions for management, assignability of interests, and distribution of profits and losses.
Bottomline: The liability of the founder/s of the startup will depend on the business structure under which it was operating.