Man and Woman Looking at Paperwork

Does a Sole Proprietorship Need Liability Insurance?

Many entrepreneurs who are the sole owners of their business (or operate a business with their spouse) choose to operate as sole proprietorships. A sole proprietorship is the simplest business structure to manage, which is why it’s popular with self-employed individuals. The sole proprietor (business owner) and the sole proprietorship (the business) are considered the same legal entity and tax-paying entity. The structure has no ongoing entity compliance formalities because it’s not a registered state entity. And tax preparation is typically easier than with other structures as business-related income and expenses flow through to the owner’s individual tax return.

Unfortunately, the simplicity of running a sole proprietorship comes with some disadvantages. The most significant is the business owner’s unlimited personal liability for the legal issues, debts, and expenses of the business.

How can sole proprietors protect their personal assets? One way is to purchase sole proprietorship liability insurance or other business insurance policies to help cover certain costs if the business encounters unfortunate circumstances.

Risks of Operating as a Sole Proprietorship

Before I discuss some types of insurance that sole proprietorships may benefit from, I want to highlight some of the risks that sole proprietors face.

With no legal separation between the business and its owner, any legal problems and financial debts of the company are those of the business owner, too. That means the owner’s personal assets (house, car, savings accounts, etc.) could be seized to pay outstanding debt to creditors, money owed to vendors, or court-awarded damages to customers if the business does not have the necessary assets.

Examples of things that could put a sole proprietorship’s business owner’s personal assets at risk include:

  • Damage to a customer’s property
  • Employee on-the-job injuries
  • Lawsuits
  • Inability to pay business creditors and vendors
  • Failure to pay business-related taxes
  • Lack of funds to pay business loans
  • Data breaches that compromise customer information

Also, sole proprietors will likely have to dip into their personal checking and savings accounts to cover any of costs related to their own business’s loss or theft of inventory, damage to business property, data recovery if affected by a breach, or other disasters if they don’t have sufficient company funds.

Business insurance policies that cover those types of circumstances and related costs can help protect sole proprietors’ personal assets.

What Kind of Insurance Does a Sole Proprietor Need?

Various types of insurance policies exist to help sole proprietors protect their business and personal assets. Below you’ll find overviews of several types of insurance business owners may want to consider. What a policy’s coverage includes or does not include may vary depending on the insurance provider and other factors.

It’s important to note that insurance policies can help cover costs (or lost revenue) associated with lawsuits, property damage, and injuries to others. However, they do not remove the sole proprietor from being held responsible for legal and financial claims against their business. Only a business owner with more formal entities (such as an LLC or corporation) can protect personal assets from liability litigants and creditors.

1. General Liability Insurance

General liability insurance helps protect business assets in the event of common liability risks when dealing with customers, vendors, or other third parties. These basic liability policies can help cover the costs associated with claims of bodily injury, property damage, defective products, and personal injury (e.g., slander and libel).

2. Professional Liability Insurance

Professional liability insurance (also known as errors and omissions insurance) covers actions (or inactions) of business owners who offer professional services to clients.

Professions that may benefit from professional liability insurance:

  • Consultants
  • Engineers
  • Accountants
  • Bookkeepers
  • Real estate agents
  • Marketing and advertising firm owners

If someone sues the business for mistakes, professional negligence, bad advice, misrepresentation, copyright infringement, failure to fulfill contracted services, or similar claims, professional liability insurance can help pay for legal fees, court-ordered damages, and lost income if unable to work while attending a trial.

3. Commercial Property Insurance

A commercial property insurance policy can help cover the costs of repairs or replacements if the business’s office, equipment, or inventory gets damaged, destroyed, stolen, or lost due to weather (e.g., lightning, hail, wind), vandalism, theft, fire, smoke, and possibly other unanticipated circumstances.

Items typically covered by business property insurance:

  • Buildings
  • Furniture
  • Office equipment
  • Tools
  • The sole proprietor’s personal property

Note that some types of disasters, such as floods, nuclear hazards, earthquakes, acts of terrorism, are often excluded from commercial property insurance policies. Some insurance companies offer special riders to extend coverage to damages not included in their standard business property insurance policy.

4. Business Interruption Insurance

With a business interruption insurance policy, a business owner can receive compensation for some of their lost income if they must stop or slow down operations due to an insured disaster, burglary, or act of vandalism.

Examples of lost income and operating expenses typically covered by business interruption insurance:

  • Lost revenue (based on what the business would normally take in if it were open)
  • Payroll for employees
  • Mortgage and other loan payments
  • Rent and lease payments
  • Tax obligations
  • Costs for relocation

There’s usually a waiting period (e.g., 48 hours or 72 hours) before a business interruption insurance policy’s lost income benefits kick in.

5. Cyber Insurance

With so much business conducted on computers, online, and through software applications, the risk of data breaches and other cyber security threats that lead to losses for companies and their customers has escalated to alarming levels. Some insurance companies offer different variations of cyber insurance (e.g., cyber liability insurance and data breach insurance) or provide coverage in a single policy to help cover legal fees, expenses, and losses.

Examples of losses covered by cyber insurance:

  • Cyber attacks (such as viruses and ransomware)
  • Phishing schemes
  • Fraud
  • Breaches of personally identifiable data
  • Cyber extortion
  • Other

If a business encounters any of those unfortunate circumstances, a cyber insurance policy can help compensate the company for lost revenue and cover costs associated with notifying customers in the event of a breach, repairing their computer network, recovering data, and other aspects of restoring operations and regaining customer trust.

6. Business Owner’s Policy (BOP)

A business owner’s policy (BOP) will bundle several types of insurance to provide comprehensive protection under one policy.

Typically, insurance carriers offer two or more of the following types of coverage in their BOP packages:

  • General Liability Insurance
  • Commercial Property Insurance
  • Business Interruption Insurance

Note that many providers have eligibility requirements (e.g., must be under a certain dollar amount in annual revenue, have no more than a specific number of employees, or aren’t involved in a specific industry).

7. Employment Practices Liability Insurance

Employment practices liability insurance (EPLI) covers legal costs resulting from legal claims related to a business’s employment practices, often those involving the violation of workers’ or job applicants’ rights.

Examples of legal issues covered by employment practices liability insurance include:

  • Discrimination (e.g., race, gender, age, religion, disability)
  • Sexual harassment
  • Privacy violations
  • Defamation (libel or slander)
  • Failure to promote
  • Breach of an employment contract
  • Wrongful discipline or termination
  • Mismanagement of benefit plans (e.g., retirement, health savings)

8. Workers’ Compensation Insurance

If a sole proprietor hires employees, workers’ compensation insurance may be required by the state (rules vary by state). Workers’ compensation insurance policies cover lost wages and medical costs associated with injuries and illnesses that are work-related.

9. Commercial Umbrella Insurance

Some insurance providers also offer umbrella policies that supplement other business liability policies. An umbrella policy extends coverage limits of other policies in the event there’s a shortfall and the other liability policies won’t cover what the business owes. The liability policies to which umbrella policies apply vary depending on the insurance company, but most do not include commercial property insurance.

Is It Better to Register an LLC or Purchase Business Liability Insurance?

That’s a difficult question to answer with a yes or no because it doesn’t involve an apples-to-apples comparison.

Registering a Limited Liability Company creates an official business entity in the state. The LLC is legally separate from the business owner. Therefore, unlike a sole proprietor, an LLC owner (member) is generally not held responsible for the debts of and legal actions against the business.

A sole proprietorship liability insurance policy may cover some of the costs and losses associated with business risks that become realities for a sole proprietor. However, the business owner is still legally and financially responsible for any claims against the sole proprietorship. If insurance doesn’t cover all the costs, the sole proprietors’ personal assets may be at risk.

Conversely, an LLC member’s personal assets are protected by the fact that the business is its own legal entity. So, even if someone sues the LLC or the business owes creditors money, under most circumstances (with some exceptions such as owner negligence, fraud, or harmful acts) the owner’s personal property and funds cannot be taken to settle the legal damages or pay off debts.

That said, in addition to registering a business as an LLC, it may also be beneficial to seek certain business insurance policies to help cover business costs and further protect personal assets in the event of the unthinkable.

How Much Does Sole Proprietorship Liability Insurance Cost?

The annual cost of sole proprietorship liability insurance can vary widely from hundreds of dollars to thousands of dollars.

Below are some of the factors that influence the cost of business insurance premiums:

  • The insurance provider
  • The type of business insurance policy
  • The industry or line of work and its inherent risks
  • Whether or not the business has employees or outsources work to independent contractors
  • Where the business is located
  • The deductible

Fortunately, for business owners who want to cover their personal assets as well as their business assets, forming an LLC is relatively inexpensive. State’s pricing and requirements vary. The one-time filing to register the entity with the state isn’t exorbitant (in some states, it’s under $100), and LLCs have few ongoing compliance responsibilities.

Choosing the Right Business Insurance Provider and Policies

Although insurance companies may use the same name for their types of policies, not all policies offer the same level of coverage. That’s why it’s imperative for sole proprietors to take the time to research providers and talk to other business owners in their field for recommendations on companies that have fulfilled their needs. Finding a knowledgeable, reputable agent capable of understanding the complexities of the business is essential because different industries and types of business activities have different types and degrees of risk.

Woman in Business Suit talking on Phone

Convert Your Sole Proprietorship to an LLC

If you’ve determined converting to an LLC is right for your business, we can help! From serving as your registered agent to filing your Articles of Organization, we make the process simple and ensure your paperwork is completed accurately and promptly.

<a href="https://www.corpnet.com/blog/author/nellieakalp/" target="_self">Nellie Akalp</a>

Nellie Akalp

Nellie Akalp is an entrepreneur, small business expert, speaker, and mother of four amazing kids. As CEO of CorpNet.com, she has helped more than half a million entrepreneurs launch their businesses. Akalp is nationally recognized as one of the most prominent experts on small business legal matters, contributing frequently to outlets like Entrepreneur, Forbes, Huffington Post, Mashable, and Fox Small Business. A passionate entrepreneur herself, Akalp is committed to helping others take the reigns and dive into small business ownership. Through her public speaking, media appearances, and frequent blogging, she has developed a strong following within the small business community and has been honored as a Small Business Influencer Champion three years in a row.

Related Posts

LLC vs. S Corp vs. C Corp

LLC vs. S Corp vs. C Corp

Yes, operating a business as a sole proprietor or general partnership offers simplicity, but that comes at the cost of not having a separation between you as an individual and your company. Are there other options? There are alternate options that include popular...

Does an LLC Get a 1099?

Does an LLC Get a 1099?

Many freelance professionals and independent contractors operate as Limited Liability Companies (LLCs). The requirements for when a business should send a 1099 form to an LLC vary, as does the 1099 form to send. Generally speaking, this is when LLCs should or should...

What Every Small Business Should Know About 1099s

What Every Small Business Should Know About 1099s

Every year when tax time rolls around, many business owners wonder whether they must send 1099s to their vendors. As commonly known as 1099 forms are, they remain one of the most misunderstood Internal Revenue Service (IRS) requirements. Recently, more confusion has...

Subscribe to Newsletter

Practical business and financial insights, lessons, perspectives, and know-how brought right to your inbox.

Thank you for subscribing!

100% satisfaction guaranteed or we will refund 100% of our service fees with no questions asked!