Besides lack of funds or mismanaged cash flow, one of the worst-case scenarios for small business owners: getting sued. Out of the 29.6 million small businesses (2017) in the US, you may think the chance of a lawsuit is few and far between. Think again. According to Forbes, 36% to 53% of small businesses are engaged in at least one suit at any time. Unlike LLCs and corporations, sole proprietorships don’t have the luxury of limited liability protection, which leaves their personal and business assets at the mercy of creditors. What can you do to protect your business, let alone yourself? We’ve got options; here are several ways to increase your liability protection when you don’t have any. (Plus, find out why you may want to do a Delaware corporation search.)
Safeguard Your Business: Invest in Business Insurance
Business insurance can help mitigate potential lawsuits. General liability insurance, according to Fox, protects business and owner from property damage and injury claims. And, it provides coverage for lawsuits, business investigations, and settlements. Despite the extra cost, general liability insurance gives sole proprietors legal protection they otherwise didn’t have.
Cushion the Lawsuit: Other Types of Business Insurance to Consider
Business interruption and property insurance, in particular, are two favorites among small business owners. Property insurance protects business furniture, equipment, and inventory from theft and natural disasters (i.e. flooding, fire, earthquake, etc.). Businesses located inside (and outside) of flood zones and hurricane and earthquake territory may want to check this out; according to The Economist, the US (along with India and China) endured the most natural disasters worldwide between 1995 and 2005.
Business interruption insurance, meanwhile, provides financing when businesses fall on hard times —funds may go towards employee salaries and repairs. Business insurance policies are not one-size-fits-all, business interruption insurance being no exception. Generally, as Forbes mentions, business interruption insurance policies will reflect what your general business policy covers. For this reason, it may be wise to personally select the types of events you want your business policy (and business interruption insurance) to cover: earthquakes, fires, flooding, you name it.
For sole proprietors who have employees, worker’s compensation insurance is a must. As Nolo states, workplace injury, although less likely than contract claims, is still very serious. With the exception of private businesses in Texas, it is mandatory for companies with employees to have worker’s compensation insurance, and it’s no wonder why. This insurance type covers injuries, medical and legal expenses, and temporary and permanent disability, to name a few.
Safeguard Your Personal Assets: Several Protection Options to Take Note Of
Sole proprietors can follow the same steps any other non-business-owner would take to protect their personal assets against creditors. Several include allocating assets to an employee-sponsored retirement plan, which provides unlimited protection from creditors (should you happen to also work for a company); putting assets in protection trusts in states like South Dakota, Nevada, Rhode Island, Delaware, and Alaska, that allow it; and even put assets under your partner’s name (however, this may be sticky if legal separation ensues).
Hire a Qualified Attorney
It goes without saying, an experienced, qualified, licensed attorney is one of your best tools in your legal arsenal should you get sued. Do your research ahead of time: check reputable legal rating sites and verify their credentials on the state bar search page. Search results should show current status, bar number, contact information, undergraduate and law school colleges, status history, and any eligibility actions that could prevent the lawyer from practicing in the state.
Consider Transitioning to Another Business Structure That Has Limited Liability Protection
As mentioned, LLCs and corporations already have limited liability within their structures. If your profits have increased considerably since becoming a sole proprietor, you may want to look into filing as another entity for more liability protection, let alone tax benefits. S corporation owners, for instance, can allot a percentage of business profit for salary (taxed) and another for dividends (tax-free). (However, dividends more than or equal to salaries is a big red flag to the IRS, and may prompt an audit.)
If you work in a sue-friendly industry like healthcare or law—or work in an industry with a high risk of workplace injury such as construction—you may not want to file as sole proprietorship, to begin with. (Depending on the state, this may not even be an option.)
Conduct a business entity search to see if your business name is available. For instance, if you live in Delaware and are transitioning from sole proprietorship to S corporation, consider running a Delaware corporation search. (Do the same for LLCs and C corps.) After running a name availability search:
For LLCs, fill out the articles of organization, draw up an operating agreement, pay the corresponding fees, publish a notice in the newspaper (requirement varies by state), and get the necessary business license and permits.
When it comes to C corps, file the articles of incorporation, dole out stock certificates to shareholders, obtain the following business license and required permits, fill out and file SS-4 form to the IRS, apply to any other mandatory state and local agencies, and pay any necessary fees.
As for S corps, draft the articles of incorporation, issue stock, file form 2553 (signed by all shareholders) to the IRS, get business license and permits, and pay all necessary fees. (Please know that past 2 months and 15 days from the new tax year, you will have to file for S corporation status the following year.)
Sole proprietors don’t have to sit back and allow creditors to take their personal and business assets. From investing in business insurance and allocating personal assets to protection trusts and employee-sponsored retirement plans (should you work for a company), you have several options at your disposal.
Under no circumstances should you mix business assets and personal assets. And, be sure to speak with a qualified attorney about the best ways you can protect yourself and your business. What do you do to protect your personal and business assets? Leave a comment below.