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Protecting yourself and your small business

When a business becomes self-sustaining, owners don’t always think about protecting their personal assets from their business liabilities.

By Rosalie Donlan

Insurance agent selling small business insurance policy
Running a small business can be a wonderful experience — as long as you do some careful planning in advance. (Photo by Getty Images)

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Many entrepreneurs start their small businesses at their kitchen tables or in their garages with limited funds. Often, they find it difficult to separate their personal and professional lives and their personal and professional financial assets. When the business gets big enough to be self-sustaining, the owners don’t always think about protecting their personal assets from their business liabilities. If you find yourself in this situation, what should you do?

Decide on a business entity

Mixing business and personal funds is always a bad idea. Your first step should be to consult an attorney with experience in advising small businesses in your state. The attorney can review the various business entities — limited liability corporation, limited liability partnership, general partnership, Subchapter S corporation or C corporation — and the pros and cons of each one. If you expect to do business with federal, state or local governments, the attorney can also advise you on the rules regarding minority businesses. With the correct structure, you can create a wall between your personal assets and your business assets, which is significant in case you’re facing significant business liabilities.

Decide on the proper form for your personal assets

You should consult a financial services advisor to determine the best way to hold your personal assets to keep them safe from potential business creditors or from judgments in a lawsuit. You may need to put investments in a trust or keep some assets in the name of your spouse or children.

Keep separate bank accounts and separate financial records. Invest in bookkeeping software, such as QuickBooks, which allows you to upload your transactions directly from your bank. You can then add the transactions to tax accounting software or to your accountant.

And it’s usually worth the investment in having an accountant prepare your annual tax return and regularly review your finances with you. The accountant can help you manage cash flow and ensure that you continue to keep personal assets separate from professional assets.

Monitor your credit

When you operating your business as a sole proprietor, your business debt is essentially your personal debt, and your business credit rating, too, is your personal credit rating. Operating your business through an entity can help keep its losses and liabilities off your personal balance sheet and off your personal credit report.

Be aware that some business loans, including business credit cards, require a personal guarantee, which means that you’ll be considered personally liable for any debt you incur or fail to pay off. When choosing financing, be sure to read the application form carefully so that you understand when you’re assuming such a responsibility. You’ll also want to ask lenders about their credit-reporting policies.

You may consider using your business credit cards as a way to cover important business expenses month-to-month. Certainly, the credit card issuers offer incentives to put your major expenses on the card. But, be aware that most major business credit cards require the small business owner to provide a personal guarantee. They will file a report on your personal credit file if the card goes into default, so be careful not to charge more than your cash flow can handle. And remember that most card issuers only report negative items, not your positive payment history to the consumer credit reporting agencies. Ask what their policy is before you apply, and be sure to comparison shop.

Have separate entities for each business

If you’re going to have several businesses, even if they’re related, they should each be operated as separate businesses. Real estate investors often incorporate each property as its own limited liability company. Restaurant owners that also own liquor stores or restaurant supply stores should operate each one independently. But be sure you consult an attorney who advises your kind of business in the state in which you want to do business. And if you’re crossing state lines, be sure the attorney can advise you on which state is most friendly to your industry.

Check on property and liability coverage

As soon as you’re big enough to have employees, be sure you have workers’ compensation insurance. In most states, it’s illegal to operate a business without it. And workers’ comp isn’t just for manufacturing businesses. Most workplace injuries are slips and falls and soft tissue injuries, such as those from lifting heavy boxes of office supplies.

If you’re renting space to operate your business, you need property insurance, including commercial general liability. And if you relocate to a building that you’ve just bought, you’ll need to update both your general liability insurance and your commercial property insurance (often bundled together in a business owner’s policy), which are tied to location.

Maintain professional liability insurance

Most business owners think that professional liability insurance is only necessary for the classic “learned professions,” that is, doctors, dentists, lawyers, accountants, architects, engineers or veterinarians. When these professionals are sued for malpractice, their homes and financial assets can be at risk without the property business entity and insurance in place.

But anyone who holds himself or herself out as someone with special skills or knowledge can be considered a “professional” in the chosen field and at risk for a lawsuit alleging malpractice or negligence. There have been cases of wedding planners and hairdressers facing suits when something went wrong.

And if you choose to add a new service to those you’ve already been offering — an architect adds interior design services, for example — be sure you speak with your insurance agent to be sure your and your employees are covered.

Have business interruption insurance

If something keeps you from operating your business — from a simple power failure to a major catastrophe like a hurricane — you need business interruption insurance to cover your expenses. Without this coverage, you may find yourself negotiating a business loan under less-than-ideal circumstances or raiding your personal savings or 401(k) accounts to keep things going and paying employees.

Running a small business can be a wonderful experience — as long as you do some careful financial planning in advance.

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