Three Basic Ways Small Business Owners Can Protect Themselves from Liability

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If you’re a small business owner, you are hustling.  You are busting your butt building your business and serving customers to the best of your ability, constantly pushing to do better – that’s how entrepreneurs are wired.  While you’re doing all of this, there may be some questions lurking in the back of your mind about liability protection for yourself and your business, but you haven’t had a chance to really look into them to determine whether they are real issues and, if so, what it will take to address them.

There are many ways that small business owners can protect themselves and their businesses from potential liability, but this article will focus on three basic ways that can serve as a good starting point for business owners.  Whether you are brand new or have been operating for a while, you may need to examine or re-examine whether you are adequately protected from liability in these areas.

  1. Business Entity Form

Are you a sole proprietor, partnership, limited liability company (LLC) or corporation?  Your protection from personal liability for your business activities will be affected by the answer to this question.  While sole proprietorships and partnerships are the simplest forms of business entities, they also come with unlimited personal liability for the business owner(s).  There is no separation between the person and the person’s business activities, so creditors or anyone with a potential claim against a business can not only reach the business’s assets, but also the business owner’s personal assets (i.e., their home and personal bank accounts).

One of the ways to protect against personal liability for business activities is to create and register a business entity, such as an LLC or corporation, and conduct all business activities out of this entity.  For many small business owners, an LLC business entity form makes the most sense because LLCs can be treated as pass-through entities for tax purposes and do not need to observe many of the corporate formalities required of a corporation.  While there are periodic (often at least annual) filing requirements that need to be met in order to maintain the entity, the resources involved in meeting these requirements may be minimal compared to the potential personal liability that a business owner may be exposed to if they didn’t operate under the registered business entity.

  1. Insurance

Running a business comes with some inherent risks and you never know what could happen that might affect your business, so having insurance to protect against those risks is a good idea.  While there are many types of insurance products available, it’s important to understand what exposures (risk areas) your business has and get the type(s) of insurance that will adequately protect against those exposures.  Among the typical types of insurance that a small business should have include, but are not limited to, general liability insurance, professional liability insurance, property insurance, commercial auto insurance, workers compensation (which may be required by law) and, increasingly, cyber liability insurance.

A good insurance broker can help you identify business exposures and recommend the appropriate insurance products – including how much insurance to purchase – for your business, so it’s a good idea to consult one.

  1. Contracts

In addition to entity form and insurance, having solid contracts is an additional way that a small business can limit liability.  In general, written contracts have the effect of getting the expectations of a relationship or transaction laid out in writing, so that the parties to the contract know what to expect and how to conduct themselves.  Getting things into a written contract is always good practice and is sometimes even required by law, depending on the subject matter (e.g., contracts involving the lease, mortgage, or sale of real property) or the circumstances (e.g., contracts that cannot be performed within a year of the contract date).

With regard to the actual substance of the contract, there are two typical contractual provisions that serve to limit a business’s liability: indemnification and limitation of liability.  So what do these mean?

In an indemnification clause, one party (party A) agrees to pay for losses incurred by another party (party B) to a third party (party C).  For example, A, a business owner, contracts with B, a construction contractor, to renovate A’s offices and the contract contains an indemnification clause where B indemnifies for certain claims arising out of its work.  If after the renovations are completed and C, a customer, is injured at A’s offices due to a condition caused by B’s shoddy workmanship, then, if C were to sue A over the injury, B would be on the hook to indemnify A from C’s lawsuit.

A limitation of liability clause will limit the level of a company’s exposure in the event of a claim or lawsuit.  If a company is found to be responsible for damages (i.e., injuries or damage to property, etc.), a limitation of liability clause will cap the amount of damages it may need to pay out.  A cap may be set at a certain dollar value or amount, be equivalent to the fees and compensation paid under the contract, be set to the amount of insurance coverage available to cover the claims arising under the contract, or a combination of these.

Entering into solid contracts with these provisions written in a way that protects your business is an important way you can strengthen your business’s protection from liability.

These three methods of liability protection represent a few of the most basic ways small business owners can protect themselves and their businesses and are most effective if used together.  As you build and operate your business, it’s important to continually assess potential risks that may affect your business because these may change as your business grows and evolves.  This means your business entity form, insurance, and contractual protections may need to change and evolve as well.

Need help getting started?  Get your questions about business entity form, insurance, and contracts answered by scheduling a complimentary 30-minute consultation with us.  Get in touch here.



The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this page are for general informational purposes only.  The scenarios used in this article to explain the legal concepts discussed above are simplified in order to illustrate the concepts and potential outcomes.  Real-life situations often involve complex facts, including varying contractual language, which may result in many different outcomes.

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