Protecting Yourself From Personal Liability
There are three main ways for protecting yourself from liability.
a) The first is insurance.
b) The second is to incorporate.
c) The third is a well written contract.
Only incorporating will actually separate you personally from any liability. Even with insurance, the liability or debt will attach to you. With a corporation or LLC the liability will attach to the company. I recommend combining all three listed above, incorporating, obtaining good insurance coverage and having well written contracts are the trifecta to ensure you are covered from a liability stand point.
Whether incorporated or not:
Get Business Insurance – I always recommend a general liability insurance policy which is usually very affordable plus any extras you may need depending on your business. For instance I also have a cyber-breach policy add on in case of a tech breach since I have sensitive client information.
Check your business name: check out the USPTO database, the state, an internet search, check domain names before you register your company name with the state or use it as a sole proprietorship name with the county. You could be inadvertently violating someone else’s trademark rights. It does happen often. You could be liable for damages to the other company.
If you are not Incorporated:
Get incorporated! – there is no liability protection or tax savings for sole proprietorships or partnerships! Yes there is some additional paperwork to be done but the tradeoff is worth its weight in gold.
Limiting Liability by Incorporating – The first and foremost advantage of incorporation is to protect yourself from personal liability. When you are a sole proprietor or partnership you are liable for the business’ debts including if you are sued. This means creditors can go after your home, your car or your personal investments to satisfy any judgments against your or any debts the business has. With a corporation or LLC, the business is the one who remains liable for all debts including lawsuit awards. The owners only stand to lose the amount that is invested in the company and nothing more. Of course there are exceptions such as a fraudulently undercapitalized corporation or personal liability for egregious or criminal conduct. However, in most circumstances your personal assets will be protected. If you are also listed as a director or officer you will need an Indemnification Agreement to further protect you from personal liability. It is still advisable to obtain business liability insurance to protect your business and its assets.
If you are Incorporated
The two main reasons for incorporating a business are:
a) tax benefits and
b) liability protection
When you incorporate an S Corporation you can save approximately 7.5% in taxes. Corporations and LLCs may be able to deduct more expenses than sole proprietors or partnerships. Corporations can offer stock option plans, retirement accounts and health benefits which may all be tax deductible expenses which can lower the overall taxable income of the corporation or LLC. Generally S Corporations are taxed at a lower rate than sole proprietorships. You may even be able to cut down on the amount of income taxes you pay as a sole proprietor or partnership since you can pay yourself as an employee of the corporation or LLC. It may seem counter intuitive, but by paying yourself as an employee of your own corporation you save about 50% on the self-employment taxes assessed to LLCs and sole proprietors.
Did you just file your articles with the state? Or did you do all other supporting paperwork? Most people aren’t aware that filing the articles with the state does not accomplish either of these goals, and the secretary of state won’t tell you that. You need a corporate book with minutes, bylaws, stock certificates, an indemnification agreement and tax filings.
What is an Indemnification Agreement?
When you incorporate, you are protected from personal liability (provided you follow all corporate formalities) as the owner of the company. Shareholders are protected from liability by statute but directors and officers are not. With the indemnification agreement if a director or officer is found liable for a decision made in the regular course of business, the corporation will pay for any court costs and judgments the officer or director incurs in defending a lawsuit or action.
Annual Minutes and Resolutions
Do minutes annually and resolutions throughout the year when necessary for a corporation or LLC. You can see the attached “When to do resolutions for your Corporation” for an idea on when these should be done.
File your annual report on time with the secretary of state, if you don’t they will dissolve you.
It is always due the first day of the anniversary of the month you were incorporated
If you are late, there are penalties and fees
If you are 5 months late the state dissolves you
If you are late your liability protection is in serious question as are your tax advantages
Mark it on your calendar, you can file 2 months ahead (It’s only $100 for a corporation)
Each business needs to check on this for each town they have a location or are doing business out of, even a home based business. Many business owners skip this step because they just don’t know about it.
After Incorporating, contracting is another major area that you can limit your liability. Whether it is one you present a customer or client or one that is presented to you.
EVERY business should have a contract whether it is a sales or a service agreement
Having a written agreement can solve so many issues before they even start.
If anything ever does go to court it can go a long way to making your case a winner (if done right).
A well written contract can discourage legal proceedings as well.
Have a contract reviewed, it is worth it if you have a good attorney.
Often times what business owners are most concerned about are the terms of the agreement, how many, how much, when do I get paid etc., but if you get to court what the attorney’s will most likely argue over are all the “boilerplate” provisions in the agreement, these can make or break most cases.
Sign a contract appropriately to avoid personal liability (if you are a corporation or LLC or registered partnership) o Sign like this for a Corporation:
Jane Doe, President
ABC Company Inc.
If you just sign your name then it’s a contract with you and not your company
Avoid a personal guarantee on a contract or lease if at all possible. A personal guarantee is what it says it is. It’s like cosigning for your business. You are promising that if the business can’t fulfill the contract then you personally will. Often times, these can be negotiated out or limited.
Try to negotiate a contract or lease, the worst the other party can say is no, often times they will say yes, don’t be timid, you can save a lot of money for your business
If you have a partner (other than a spouse) you should have a shareholder/partner agreement. Circumstances can come up that neither you nor your partner expected, what happens if one of you becomes incapacitated, what if one dies? Do you want to be in business with their heirs? What if one of you wants out? How will you decide what the company is worth? What if one partner stops participating? What if there’s a deadlock? What if you just want out?
This is a big area where you can limit your liability and your costs. I do a separate presentation on this alone because it is the biggest expense for most small businesses. When you are handed a lease you can bet that it is geared to protect the landlord and not you, or it is an agreement they pulled off the internet which will also not protect you. Get it reviewed.
Make a contract work for you.
If you have employees (other than yourself) have an Employment Agreement.
If you use Independent contractors then have an Independent Contractor Agreement.
If you hire someone to design a logo, do artwork, create text, create software code then you must have an agreement addressing ownership of the intellectual property. Otherwise the author/creator will retain ownership.
Most importantly, trust your senses. If something seems off or wrong then be willing to walk away from a contract, a lease, a landlord or a customer. People often get in trouble for not trusting their instincts. If something doesn’t feel quite right then it probably isn’t. Many new business owners will take on a client that sends up red flags because they need the money, but that client could cost you more in the end. Listen to your sixth sense.
Business Ending & Dissolution
If you do need to end your business file the appropriate paperwork with the state and the IRS, otherwise they won’t know and it could cause tax consequences. If you are incorporated you can limit the time for anyone to file a claim but you must actively do this.
Overall, don’t do short cuts, you can be frugal in getting things done right. It shouldn’t cost a fortune but it does need to be done right, at the start of the business or at the start of a new relationship. But late is better than never.
The number one, biggest legal advice I can give is to NOT use forms off the internet or elsewhere that are not tailored to your needs, or to Illinois law or even to current law!