The importance of having a business, no matter how small, has never been under so much attention as it is today. Surging unemployment rates forced the laid off; even those who are lucky and still have work to go to, are looking at alternative income opportunities. Some of these opportunities are freelancing, ghostwriting, day-trading and owning a small business. All these alternatives carry with them certain risks such as potential legal liabilities. For now, this Factoidz concentrates on how small business owners can avoid legal liabilities.
First, your decision on what form the business will take will impact your legal liabilities in the future for as long as your business is in operation, and even beyond that. There are generally three ways you can organize a business:
1. Corporation is a separate legal entity which can do business on its own.
2. Partnership is a business owned by two or more joint owners who share among them the responsibilities of managing the business and the profit therein.
3. Sole proprietorship is a business owned and managed by a single person
Second, how are legal liabilities dispensed of in each of these forms of business organizations?
As a separate entity, a corporation can buy and sell real properties. Moreover, owners of corporations, who are called stockholders or shareholders, enjoy the protection of limited liability. Limited liability means that, as a rule of thumb, that any shareholder will only lose up to the amount he or she invested. If you spent $10,000 for your 10% ownership interest in a corporation, then you will only lose up to $10,000.
In a partnership, the owners who are called partners are individually liable for the liabilities of the business. For example, you invested $10,000 in the partnership and the partnership owes a total of $50,000. The "individually liable" means that partners stand to lose more than $10,000; thus creditors can go after the partners’ personal properties to satisfy the debt. As a matter of fact, the creditors can go after your personal property to satisfy the entire $50,000 liability of the partnership. However, the partner who the creditors went after has recourse of going after the assets of the other partner(s) until such time that the proportionate shares of the other partners on the debt owed is satisfied. If your partner’s share on the $50,000 is $25,000, then you can go after his or her personal assets to satisfy that portion.
In a sole proprietorship, you alone bear the burden of paying off the debts of the business. Say, you have invested $5,000 in the business, but at the end of the day, the business owes $10,000; then creditors have recourse to seize $10,000-worth of assets to satisfy the debt.
Third, owning and operating a business carries risks that no matter how efficient and effective management is, still leave exposure to legal liabilities. One way to shield your personal assets from these liabilities is to take out insurance.
Say, a partnership operating a clinic can take medical malpractice insurance. Therefore, a business owner, regardless of the form of organization, has to insist that insurance for possible legal liabilities be taken out. What a prudent business owner needs to do then is to sit down and identify the possible legal liabilities of the business. After which a local insurance broker has to be contacted and consulted on whether there are insurance policies offered for these specific legal liabilities.
Lastly, insurance is a business necessity. If you own a business, don’t hesitate to take out insurance for any possible legal liability and loss. After all, the insurance premium is a business expense and therefore deductible.
Happy investing everyone!
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