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One of the main reasons to create an LLC or to incorporate revolves around asset protection. The business structure legally separates the assets of the ownership from the assets of the company. The corporation may be sued (and even go bankrupt) without loss of personal property by the ownership.
In many cases, creditors will try to show that a company does not meet the requirements for that entity. If they can do so, a judge may rule that an LLC (for example) is really a sole proprietorship (or a partnership) – putting the owners’ personal goods at risk. In other cases, the actions of an owner in the course of doing business may breach any protection incorporation offers.
In most cases, relying on a corporate shield to prevent problems is not enough. Business insurance is available for all business structures and should be obtained. Specialty insurance by type of business is also a good idea. Some common policies available include:
As when purchasing any insurance, it pays to shop around. A Business Owners’ Policy (BOP) may be available from some carriers. The BOP combines several types of common insurance into a package and can save costs over separate policies.
There are many types of vehicles available to businesses (especially corporations) that allow protection from lawsuits. These may be trusts, pensions, health care plans, and tying up company assets with other obligations. Keeping assets and debts balanced (as with a mortgage) is a common way to protect a business from legal action. In this latter scenario, all excess value is passed out of the business and to the shareholders whenever possible.
One trap that small business owners must avoid is being too loose with records and separation of the business financials from their personal assets. Called comingling, this occurs when owners mix their money with company money. Only clear records of all asset transfers will keep personal finances separate from company assets. Avoid, whenever possible, giving a personal guarantee for a company loan. Banks usually insist on it, but supplier may waive all or part of it to get your business.
Corporate managers must also insulate themselves. In the small business situation, having one spouse as director/manager while the other (also an owner) keeps entirely separate from the business may help. There is also officer/director liability insurance available to cover negligence suits.
One of the best protections is education. Knowing what activities increase risk and keeping all company business within standards goes a long way to avoiding a business killing lawsuit.