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Understanding the Law: What Every Entrepreneur Needs to Know About Liability 

Small Business

Maybe you’re a freelance writer, run an HR consulting company, web design, or custom handbag business. These are hardly risky ventures and liability is probably furthest from your mind. After all, how much trouble can you really get into, sitting behind a computer and talking to clients?

While it’s true that some businesses are inherently riskier than others, all business owners (including freelancers) should be familiar with potential liability issues and what they can do to minimize the risk.

1. Minimize your personal liability with a formal business structure

The first thing to know is when you have a sole proprietorship and you’re sued, you’ll be sued personally. This puts all your personal assets (such as your retirement savings) at risk. Certainly, no one goes into business expecting they’ll be sued and chances are, nothing like this will ever happen to you. However, if the worst-case scenario happens (for example, an unreasonable client gets angry and wants to take you to court), you’re putting everything at risk.

You can address this risk by creating a formal business structure like an LLC or a Corporation. Once your business is incorporated (or is an LLC), it exists as a separate entity. The business is responsible for all of its debts and liabilities, and not the owner. This is often called the ‘corporate shield’ or ‘corporate veil’ since it separates your personal assets from the business.

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The other thing to keep in mind is that creditor judgments in the U.S. can last up to 22 years. So even if you’re just starting out and don’t have significant personal assets to worry about protecting today, you still need to think about protecting what you might have tomorrow, after your business is a huge success.

The good news is that forming an LLC or incorporating a business is relatively easy to do. The LLC is a particularly good option for businesses that want to minimize their personal liability, but don’t want to deal with a lot of extra paperwork and administrative requirements.

2. When you’re still liable after incorporating

Creating a formal business structure is an important step to minimize your personal liability, but don’t think that it gives you a license to do whatever you want. There are still several circumstances where you could be personally liable, particularly if you operate your business illegally or your actions result in an injury. In addition, if you personally guarantee a loan for your business (which can be quite common), you will be personally responsible for this. And your ‘corporate shield’ as described above can be pierced (and you’ll be personally liable) if you don’t keep your business compliant by failing to file any of the required paperwork.

3. Do you need business liability insurance? 

Getting business liability insurance can protect your business from personal injury or property damages in the event there’s a lawsuit. You should take a realistic look at the potential risks and decide if insurance is required for your business. In some cases, small business owners are satisfied in knowing that their personal assets are protected by their business structure.

If you are interested in insurance, there are a few types, depending on your business needs:

  • General liability insurance protects your business from injury claims, property damages, claims of negligence and advertising claims. For many businesses, this is the only kind of insurance they ever need.
  • Product liability insurance protects against any losses that result from a defective product. This kind of insurance is usually needed by companies that manufacture, distribute, or sell a product.
  • Professional liability insurance protects business owners who provide services against malpractice, errors, negligence, and omissions. This kind of insurance is often needed by licensed professionals, such as doctors.

An ounce of prevention… 

You’ve probably heard the saying, “An ounce of prevention is worth a pound of cure.” This is particularly true when it comes to running your business. While most entrepreneurs will never encounter a lawsuit or liability issue, it’s always best to take some realistic steps to prepare for a worst-case scenario. A few proactive steps upfront can save you from serious headaches down the road.

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