Limiting liability is one of the largest concerns for any business owner. Sometimes it’s in the form of asset protection, other times it’s minimizing business and (especially) personal losses. Regardless, there are crucial steps you can take to reduce and even prevent liability.
First and foremost is my favorite tool in business, Contracts. With regard to preventative measures, contracts can shift the burden of risk from the start. If you are the seller and the buyer agrees to carry the burden of risk (notwithstanding some statute or regulation), then you’ve just established a solid layer of limited liability. If that clause is coupled with a Limitation of Liability clause, a provision disclaiming warranties, and add a sprinkle of indemnification, then you have a great recipe for protection. Contracts are incredibly powerful, and if properly written and executed, will often be supported by mediators, arbitrators, and courts.
The next layer of protection is Insurance. This may take the form of business liability insurance, disability or life insurance to fund a buy-sell agreement or insurance on your employees such as key-person insurance or workers’ compensation. I have worked with a number of real estate investors who do not have any entity formed (the next layer of protection) but have enough insurance to cover any losses the business may have. These preventative measures effectively result in hedging any losses from your business (like having to sell your real estate investment) and from you personally (since you are susceptible without an entity formed).
3. Entity Formation
Once your contracts and insurance are in place, be sure everything is done through your entity. Choice of entity can heavily influence your operations, taxation, and limiting your liability. Sole proprietors and partnerships do not limit your personal liability (so you should definitely make sure that your contracts and insurance are in place). However, in just a few minutes and for under $100 (in Indiana) you can protect your personal assets from claims against your business. You simply request from the Secretary of State an entity that has limited liability, such as a corporation, limited partnership, or (my favorite) a limited liability company (LLC). There are requirements for all of these entities to retain your limited liability, but they are a small cost to pay for the alternative of possibly losing your personal home or car.
4. Record Keeping
The fourth most effective step you can take to limit your liability is to keep records. Keep minutes for your meetings to prevent disputes between partners or shareholders. Keep your books in order with proper independent accounting, just in case the IRS has questions. Further, keep your receipts and invoices in an organized manner. If applicable, keep records of incidents that occur during business hours or on business property. If someone were to question what happened, it can be very powerful CYA to back up all of your statements with regularly kept business logs.
5. Watch who you work with
Finally, and I cannot emphasize this enough, watch who you decide to get into bed with. Some situations may be caused by nepotism or friends or family (See my blog on Personal Partners). Other situations may arise from shady dealers or the tantamount of con-artists. Many times you will feel that there is something wrong with the situation in your gut. Trust that feeling.