What Every Small Business Needs to Know About Liability

It only takes one lawsuit to wipe out your personal and business assets. Protect your company with these tips.
CEO and Founder, Corpnet.com
May 04, 2012

Doctors, daycare owners, bungee jumping operators–these are professions typically associated with risk and liability. But what about more "virtual" professions like a social media consultant, blogger or app developer? It’s hard to imagine that sitting behind a computer can put you in any real danger of a lawsuit, right? 

While a job in tech may be less risky than being a plastic surgeon, things can (and do) happen. A freelance writer could unintentionally plagiarize someone’s work or end up leaving an exclusive smartphone prototype at a bar. But problems aren't exclusive to an editorial or content-based company: An advertiser might fail to pay (making it impossible for you to pay your own vendors) or a less-than-reasonable client may choose to sue for breach of content.

These are all worst-case scenarios, and there’s a slim chance you’ll ever encounter anything similar. However, as a freelancer, contractor or small business owner, it’s your job to protect yourself from these dangers. Read on to learn more about what you can do to minimize your risk as much as possible.

Minimize Personal Liability by Incorporating

If you’re sued as a sole proprietor, you’ll be sued personally. This puts everything—from your retirement savings to your house and other assets—at risk. Once your business is incorporated (either by forming an LLC or corporation), it exists as a separate business entity. This means that the corporation (and not you, the owner) is now responsible for all of its debts and liabilities. In the industry, we call this the "corporate shield," as it separates your personal assets from those of the business.

What if you’re just starting out and don’t have many significant assets to worry about? If you’re sued today, your personal assets may be vulnerable for up to 22 years—long after you’re a huge success. So it’s important to think about protecting not only the assets you have today, but also whatever you might have tomorrow.

Fortunately, forming an LLC or incorporating is relatively easy to do. In particular, the LLC is great for smaller businesses who want to protect their personal assets with minimal red tape and administrative requirements.

Personal Liability

Although incorporating or forming an LLC is a critical first step to minimizing personal liability, this measure doesn’t unconditionally protect you from personal liability. There are several circumstances where you can still be held personally liable, for example:

  • You personally guarantee a loan for your business
  • Your actions result in an injury
  • You commit a crime or operate your business illegally
  • You do not operate your business as a separate entity (you commingle your personal and business finances)

Business Liability Insurance

Business liability insurance can protect your small business from personal injury or property damages in the event of a lawsuit. Liability insurance comes in different forms depending on your business needs, so you should discuss your specific business risks with an insurance agent or broker who’s familiar with your industry.

There are three key types of business liability insurance. Refer to the U.S. Small Business Administration for a thorough overview of the following:

  • General liability insurance. This protects your business from injury claims, property damages, claims of negligence and advertising claims. Depending on your business, this may be the only kind of insurance you need.
  • Product liability insurance. This type protects against financial loss as a result of a defective product that causes harm. This insurance is geared toward companies that manufacture, wholesale, distribute and retail a product.
  • Professional liability insurance. This protects business owners who provide services against malpractice, errors, negligence and omissions. In some professions, you may be legally required to have coverage (e.g., if you’re a practicing doctor in certain states). And some business contracts will require independent consultants (even technology consultants) to have their own coverage.

The Bottom Line

Incorporating or forming an LLC is an essential first step, followed by some common sense and liability coverage if necessary. No matter how small your business or what industry you’re in, it’s important to take your business and liability concerns seriously. A few proactive steps upfront can save you from serious headaches and financial hardship down the road.

Do you have liability insurance? How else do you protect your business from lawsuits?

Photo credit: Thinkstock

CEO and Founder, Corpnet.com