Asset Protection

When business owners come under fire from claims by creditors or other business liabilities, it’s not just their business assets that are exposed. That’s especially true if your business is structured as a sole proprietorship.

Most businesses in the United States are formed as sole proprietorships. While sole proprietorships are easy to form and enjoy complete and uninterrupted control over their business, they also come with unlimited personal liability. For sole proprietorships, there is no legal distinction between the business owner and he business. The IRS and other government authorities do not consider sole proprietors’ business activities to be separate from their personal activities. What that means for sole proprietors is that any claim against the business, can reach the assts of both the business and the owner.

Here are the ways small business owners can protect themselves and their businesses against liability claims.

Limit Liability with an LLC

If your goal is to simply to protect your personal assets against business liabilities, the most effective and inexpensive way is to accomplish that is to change the business from a sole proprietorship to a Limited Liability Company (LLC). As the name implies, its primary purpose is to create a separate entity that can shield a business owner’s assets from business-related liability claims. Incorporating your business as a C-corporation or S-corporation can accomplish the same thing, but an LLC is much simpler and cheaper to set up.

However, not all states afford the extra protection of individual interest within the LLC. It would be important to check your state’s law and determine whether you might need to choose a different state for your LLC residency.

The Importance of Liability Insurance

The first line of defense for business owners is to transfer the risk of liabilities to an insurance company through the purchase of liability insurance. With most liability claims, your liability insurance policy is likely to divert claimants away from your business and personal assets as they are more apt to pursue the insurer’s deep pockets and avoid the cost and hassle of litigation.

For businesses with relatively simple needs, a business owner’s policy (BOP) can provide protection for both property and general liability in a single policy. However, businesses in industries with specialized risks may require a commercial general liability policy along with more specialized coverages. 

Here are the most important types of liability coverage all business owners need to consider:

Business liability insurance: Protects your business from general liabilities such as personal injury, property damage, advertising injury, and fire damage.

Professional liability insurance: For businesses that offer advice, expertise or services, such as attorneys, CPAs and financial advisors, professional liability coverage, sometimes referred to as errors and omissions coverage protects against claims of negligence.

Umbrella liability policy: A personal liability policy designed to protect against catastrophic losses.  Generally, umbrella liability coverage kicks in when the liability limits of other insurance are reached.

Liability insurance not only covers the costs of damages, but it can also help cover the cost of defending or settling the litigation. Without the coverage, the defense costs alone could create a severe financial hardship even if your company wins the lawsuit.