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Basic Liability Limitation Techniques for the Small Business Owner

By: Jeffrey M. Bellamy, Esq.

Risk is part of everyday life.  In both your business and personal life, you evaluate risk in any relevant decision you make.  Is this car safe?  Is this food healthy?  Will I lose money on this investment?  These are examples of how we analyze risk in our day to day lives.  For the small business owner, there may be less insulation between risk and possible loss than for a peer whose earnings come in the form of a salary paid by a larger corporation.  Hence, considering risk and ways to limit it should be part of the business owners’ regular review of the health and stability of their enterprise.

Marketing and advertising can help a small business focus on growth by finding more clients and creating either a broader or more profound presence in the marketplace.  However, a natural consequence of growth is increased risk exposure.  New clients or customers bring the possibility of financial rewards through serving their needs and sending those clients out to act as future referral sources.  But, that same new customer also represents an additional point of exposure to risk, as does a new vendor, new employee, new business partner, and so on.   A dishonest partner or sloppy employee can destroy a business in a fraction of the time it took to build it.  So, as you think about marketing and growth strategies, it is also important that you balance it with risk management strategies, as well.

Books on the topic of ‘risk management’ fill several shelves at the local bookstore or library.  However, even with all of the available analysis on the topic, good risk management can be accomplished using a basic three-part method; forming and operating a limited liability entity, using third-party insurance, and implementing sound business practices.  While there is no way to eliminate risk associated with running a business, implementing this three-part method will reduce significantly an owner’s personal liability for claims arising against the business.  What follows is a brief analysis of how each part works on its own and together.

Forming and Operating a Limited Liability Entity:

If you are operating a business that interacts with the public in any way, then your business has enough risk exposure to justify forming a limited liability entity.  Put simply, if you are operating a business, you should incorporate.  The primary benefit of forming a limited liability entity is that, when formed properly, state law recognizes that entity as a wholly separate legal ‘person’ distinct and separate from its owners and organizers.  The effect of this ‘legal fiction’ is that when the entity is properly formed, organized, and operated, the claims and liabilities arising against the entity will not pass through to the owners of the entity.  Those liabilities will be attributable to the entity alone.  While there are several forms of limited liability entities, such as S-Corporations, Limited Liability Companies, and Limited Liability Partnerships, each accomplishes the same basic purpose of shielding the personal assets of the entity’s owners from the creditors, judgments, or other obligations of the entity.

Third Party Insurance:

After forming a limited liability entity to shield a business owner against personal liability for business risk, the next step is to pool the business’s risk with other businesses and individuals.  This is done through purchasing insurance.  Buying insurance is the equivalent of purchasing admission into a club where all the other members are risk conscious businesses and individuals.  By agreement a portion of every members’ ‘admission’ is pooled to pay potential claims arising against the members.  If a limited liability entity is a shield protecting business owners from personal liability, third party insurance either funds the legal defense of the entity or pays claims that arise against it.  While limited liability entities protect business owners from losing their personal assets to business claims, third party insurance protects the business from losing business assets to claims.  Using an entity without insurance would make investment and growth of a business a moot point – while the owner’s home, car and personal funds would be shielded by the entity, only one major judgment against the business would wipe out all its assets without the backing of insurance.

Sound Business Practices:

Using sound business practices runs the gamut of sophistication for operating a business; from developing and refining detailed internal safety protocols to using good old-fashioned horse sense.  While incorporation and insurance are reactions to unseen risks, developing good business practices are proactive methods to steer clear of risks before they become liabilities.  So many business practices are industry-specific; it would be impossible to cover all of them for the purposes of this review.  However, some areas which affect almost all businesses are employees, premises, government, vendors, and customers.

For employees, some suggestions are using good screening and hiring practices, uniformly enforcing company employment policies, investing in training, and retention of quality workers.  For premises, some suggestions are complying with local licensing and permitting, keeping the premises safe for customers and employees, and developing a security or loss prevention plan.  Regarding government, know the regulations affecting your industry, especially in the area of taxation.  When dealing with vendors, know the markets for competitive prices, use good written contracts, and take the time to learn about your vendors to develop trust in their product, service and reputation.

Finally, and most importantly, for customers, use several of the previously mentioned techniques such as providing safe premises and using good written contracts where appropriate (or required by law).  But moreover, work to develop and maintain a reputation for excellent customer service.  In the most basic terms – happy customers don’t sue. Though it seems an oversimplification, customers, vendors and employees who are treated with professionalism, respect, patience, and fairness, even in the midst of serious disagreements, are less likely to turn to litigation (or violence!) to resolve the dispute.  While this is entirely within the control of a business owner, it is amazing how frequently it is overlooked.

If you are operating a business, even as a supplement to another job, or are otherwise self-employed and not using the techniques mentioned above, you could be compelled to pay the obligations of the business out of your personal bank account, with your car, a family heirloom, or even your home.  This should be sobering.  If you have employees, are you able to monitor them at all times?  If you are monitoring them at all times, why are you doing so?  The point of hiring others to assist you is to delegate responsibility so you can do other tasks.  Because you cannot be two places at once and may not be able to prevent an accident even if you could, you should implement these basic risk avoidance techniques.  Develop relationships with qualified insurance, accounting, and legal professionals.  Fortune 500 companies have insurance, accounting and legal departments; you should not act differently.   In doing so you will be on your way to minimizing risk, protecting personal assets, and improving your business’s chance for future success.  And you might find some peace of mind in the process.

Practical Advice, Personal Attention

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