One of the main reasons to create an LLC or to incorporate revolves around asset protection. The business structure legally separates the assets of the ownership from the assets of the company. The corporation may be sued (and even go bankrupt) without loss of personal property by the ownership.
Risk Ranking by Structure
In many cases, creditors will try to show that a company does not meet the requirements for that entity. If they can do so, a judge may rule that an LLC (for example) is really a sole proprietorship (or a partnership) – putting the owners’ personal goods at risk. In other cases, the actions of an owner in the course of doing business may breach any protection incorporation offers.
- Personal assets are most at risk with a sole proprietorship – there is no separation between the owner and the company.
- A partnership may offer some protection, but usually all partners are sued jointly and severally unless one partner can lay blame on another due to negligence.
- An LLC has more protection, but risk still exists when the ownership is also managing the company.
- The most protection comes from a corporation with management and ownership completely separated.
In most cases, relying on a corporate shield to prevent problems is not enough. Business insurance is available for all business structures and should be obtained. Specialty insurance by type of business is also a good idea. Some common policies available include:
- Bonds – these can be performance bonds for a single activity or a general bond for all business activities of a type. Commonly, they are required for large contracts or those with serious risks.
- General Liability and Product Liability insurance. These policies protect against claims of negligence (not criminal) or performance of an item for sale.
- Professional Liability insurance, or malpractice insurance – common when a licensed professional does business with the public. They usually include an ‘errors or omissions’ rider.
- Commercial property insurance – this is the equivalent of a homeowner’s policy in the business realm.
- Home business insurance – also called home-based business insurance, this is a newer type designed for those who work out of their residences. The liability generated by working from home is usually not covered by a homeowner’s policy although it may be added on instead of being wholly standalone.
- Insurance specific to employers includes Workers’ Compensation insurance, Unemployment Insurance (usually levied as a State tax) and Disability Insurance.
As when purchasing any insurance, it pays to shop around. A Business Owners’ Policy (BOP) may be available from some carriers. The BOP combines several types of common insurance into a package and can save costs over separate policies.
There are many types of vehicles available to businesses (especially corporations) that allow protection from lawsuits. These may be trusts, pensions, health care plans, and tying up company assets with other obligations. Keeping assets and debts balanced (as with a mortgage) is a common way to protect a business from legal action. In this latter scenario, all excess value is passed out of the business and to the shareholders whenever possible.
One trap that small business owners must avoid is being too loose with records and separation of the business financials from their personal assets. Called comingling, this occurs when owners mix their money with company money. Only clear records of all asset transfers will keep personal finances separate from company assets. Avoid, whenever possible, giving a personal guarantee for a company loan. Banks usually insist on it, but supplier may waive all or part of it to get your business.
Corporate managers must also insulate themselves. In the small business situation, having one spouse as director/manager while the other (also an owner) keeps entirely separate from the business may help. There is also officer/director liability insurance available to cover negligence suits.
One of the best protections is education. Knowing what activities increase risk and keeping all company business within standards goes a long way to avoiding a business killing lawsuit.