5 Ways for Entrepreneurs to Limit Liability and Exposure to Lawsuits
There’s no way around it. Starting a new business is risky. There’s no guarantee things will work out the way you envision them. While we all imagine ourselves building a 7 figure business empire that will last a lifetime, the reality is that we’re more likely to end up one of the 7 in 10 businesses that fail within the first 10 years. Of course, not all failure is created equal. For example, there a big difference between shutting down your business by choice to pursue something else and being forced to shut down your business because you can’t afford to keep the lights on.
I imagine that when it comes to the worst ways to fail in business, having to shut your doors because of a lawsuit probably ranks up there among the worst of the worst. For any entrepreneur, being sued is a nightmare scenario. Even if you’re in the right, just the cost of fighting a lawsuit can be enough to ruin a business.
Unfortunately, it’s impossible to completely eliminate the chance of being sued. However, there are ways to limit your liability and exposure to lawsuits. It’s important for new entrepreneurs to be aware of them in order to protect themselves and their business.
1. Form a Business Entity
Forming an independent business entity is one of the simplest ways to limit liability. LLC’s and corporations provide personal liability protection to business owners. Personal liability protection means that the owner of a business is not personally responsible for the business’s debts.
Personal liability protection won’t prevent a lawsuit. Furthermore, it doesn’t provide any protection to the business itself. However, it does provide a safety blanket for business owners because liability is limited to the business’ assets. If the business is sued, the owner’s personal property is protected (e.g. bank account, real estate, etc.). That is how forming a business entity limits liability and exposure to lawsuits.
It is important to note that this protection is not absolute. Business owners can lose their personal liability protection. However, it is pretty uncommon. Entrepreneurs who abide by the law, manage their businesses responsibly, and don’t treat assets of the business as if they are personal assets are unlikely to have any issues.
2. Buy Some Insurance
Insurance is one of the most well known ways to protect against risk. Not just in business, but in general. In essence, an insurance policy transfers the risk of a specific activity from your business to the insurance company. In exchange for covering you against that risk, you’ll agree to pay the insurance company a premium.
Businesses can purchase insurance to limit liability and exposure to potential lawsuits that are common in their industry. For example, businesses protect themselves from the risk of someone getting hurt in their store with a premises liability policy. If someone falls down their stairs while shopping, the insurance company should step in and cover expenses related to that incident. Similarly, if a business sells products they may decide to purchase product liability insurance. This would help protect them from the risk of someone being injured by their products.
The nice thing about an insurance policy is that it not only covers the cost of paying the other side if you lose a lawsuit, but they can also pay for the expenses of defending your business agains the lawsuit. This is particularly important for new businesses that don’t have a ton of extra money to pay for an attorney.
Business owners looking to limit their exposure to lawsuits through insurance need to understand the risks associated with their business. You can find an insurance policy to cover just about anything. But insurance companies can be slick. If they can find a legitimate way out of paying out on a claim they will. So it is important to understand what activities are most likely to lead to a lawsuit in your business, then find the right policy to protect against that risk.
3. Create a Contract
I’ve written about the importance of contracts before, and I’m not ashamed to pound the table about their importance every chance I get. Written agreements are part of the foundation of every successful business. Not only are they the backbone of successful business relationships, but they can also help limit liability and protect businesses from lawsuits.
Well, if an issue comes up, a clearly written agreement will let the parties know how to handle it. Best case scenario, the contract will spell out a solution in black and white. Both parties can agree on who must do what, and court can be avoided all together. Alternatively, it is fairly common for contracts to require that you try mediation instead of going to court. I’ve written about the potential benefits of mediation in the past. It’s a great way to find a win-win solution to a problem. Additionally, mediation is not as expensive or destructive to relationships as litigation. Furthermore, you can limit liability in a contract by passing on the risk of an activity to the other party.
Of course, it’s impossible to predict every potential issue that may come up. In that respect, contracts are an imperfect risk management tool. Which is why they should be used together with the other tools on this list.
4. Create a Plan
Planning is the glue that holds it all together. It is impossible to develop an effective risk management strategy and limit liability without taking the time to plan. Yes, IMPOSSIBLE!
Why? Because you can’t protect yourself from risks that you don’t see coming. When it comes to running a business what you don’t know can, and probably will, hurt you. Thoughtful planning helps you identify risks more effectively. Once you’ve identified the risk, you can develop a plan to address it using the tools listed above.
Don’t believe me? Consider this hypothetical example.
Let’s say you’re an aspiring comedian. To get your name out there, you plan to make videos and post them on YouTube. Instead of wasting time planning you decide to jump right into creating because you don’t want to lose time. Six months later, you’re blowing up. Your videos have been viewed over a million times, and you’re building up quite a following.
Then one day you log onto your Youtube account and find that your account has been deleted. You do some digging and find out that the copyright owner of the song you were using in your videos has filed a DMCA takedown request. To make matters worse, a few days later you receive a letter in the mail from the copyright owner’s lawyer demanding that you pay thousands of dollars in damages or they will sue you. Not good.
Once you step in a big soft pile of doo-doo, its stuck to the bottom of your shoe. Got each step you take feeling all mushy and sticky. And now you walking around smelling like poop. Got the smell all up in your nostrils. Your day is ruined. Even when you get home an have a chance to wash them off, you’re just as likely to set them aside and think to yourself ‘I’ll handle that later.’ Because cleaning doo-doo off the bottom of your shoe is too much work.
Now, wouldn’t it be better to avoid stepping in it in the first place?
One More way to Minimize Risk…
Surround yourself with a team of professionals. As I said before, what you don’t know can, and probably will, hurt you. And as a new entrepreneur, there’s a lot of useful information you simply haven’t learned yet. You didn’t become a business owner to learn how to draft an indemnity clause, or to learn the difference between a general liability policy and an umbrella policy. Your time is too valuable to your company to waste time doing things that you can hire others to do for you. So build a team of professionals to help you navigate the risks that your business faces.
It’s never been easier to add a legal professional to your team. MZA Legal offers simple legal solutions designed to help new entrepreneurs set a solid foundation for their business. Give us a call to learn how we can help you find freedom and grow generational wealth.