If you run a catering operation, manufacture a weight-loss product, or own a tattoo parlor, then you most likely have thought about liability issues. But what about less risky entrepreneurial pursuits such as being a freelance writer, social media consultant or software designer? Can sitting behind a computer really put you at risk of being sued?
Here we’ll break down the details surrounding liability and running a business. While the goal isn’t to scare anyone away from the joys of being in charge, you need to be aware of your personal liability. Because no matter your business type or industry, things don’t always go as planned and the more you know ahead of time, the better you can prepare in order to minimize your risk.
Exploring the worst case scenarios. There’s a slim chance that your business will ever be sued or run into legal trouble. However, we do live in a relatively litigious society, so it’s a good idea to take a realistic look at some of the potential risks associated with your business.
Related: How to Protect Your Personal Finances From Business Risks
For example, what happens if a freelance writer accidentally copies from an article she read a few months ago? Or a delivery driver slips on your creaky steps while delivering a package for your business? What happens if you cross paths with an irrational client who decides to take you to court for breach of contract? Or maybe your top client never pays you, making it impossible for you to pay your own business obligations?
Again, these are all worst-case scenarios, so there’s no reason to start panicking. However, a little upfront preparation can help you avoid stress and financial difficulties down the road.
Sole proprietors and general partnerships are personally liable. If your business does not have an official business structure (meaning you run a sole proprietorship or a general partnership), then there is no separation between your business and you as an individual. This means that if your business is sued, then it’s just like you are being sued personally. Any of your personal assets can be included in the settlement.
Even if you don’t have significant personal assets right now, you still need to think about separating personal from your business. Creditor judgments in the U.S. can last up to 22 years. So if your bank account is pretty low today, you should still be thinking about protecting whatever assets you’ll have a decade or two later.
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Keep it in silos. Separating your business assets from your personal entails more than just opening a separate business bank account. The critical first step is to create a formal business structure for your company, such as a limited liability company (LLC) or corporation. Both of these entities shield the owner’s personal assets from the liability of the company.
Once you incorporate a business or form an LLC, the company now exists as its own business entity. The business is responsible for any of its debts and liabilities, as opposed to the business owners. This is often called the “corporate veil” or the “corporate shield,” since it helps to protect the owner’s personal assets from any liability of the business.
Whether you choose to incorporate or form an LLC will ultimately depend on the specifics of your situation. Larger companies, or ones who will seek VC funding or an IPO, usually opt to become a corporation. In addition, incorporating typically makes sense if you plan on investing the bulk of the company’s profits back into the business.
The LLC is often preferred among small businesses, since it has fewer formalities and paperwork requirements than the corporation. This can make it simpler and more affordable to start and maintain. In addition, the LLC, along with the S Corporation, can give you a more favorable tax treatment (for some situations), since you can avoid the “double taxation” burden associated with a C Corporation. You can speak with a tax advisor or do your own research to learn more about how these entities are taxed.
Formalizing your business is just the first step. Don’t make the mistake of thinking that once you incorporate or form an LLC that you are unconditionally protected from any personal liability. Whether your business is a corporation or a sole proprietorship, you can still be personally liable in several situations, such as if you commit a crime, your actions injure someone, or you don’t keep your corporation or LLC in compliance.