Starting out, it might not seem like such a big deal for some business dealings to overlap with your personal life. However, small business owners should be aware of the dangers they are putting themselves and family in should an incident happen, especially if they are not properly protected. It is important to keep in mind that 44% of startup firms self-identify as medium and high credit risk, according to a Federal Bank of New York Survey, which also found that nearly half of those who reported credit risk scores used personal – instead of business – scores.
There are major differences between personal and professional liability. Here’s what you should know about each.
Personal vs. Professional Liability: What’s the Difference?
Most small business owners prefer to separate their own liability from that of their company. This protects them should their company be sued for any reason. It seems like a no-brainer for companies that engage in high-risk activities like an adventure tourism business, but what about for businesses with more benign operations? Small business owners can still be pulled into the affairs of their company for a number of reasons such as if the company defaults on a loan that you personally secured or if your business commits a crime. That’s why many small business owners take the steps to legally separate themselves from their company before also getting professional liability insurance in case the worst-case scenario should occur.
The best way to see personal versus professional liability at work is to look at examples of it in the business world. Let’s look at one of those more benign business activities we were talking about: marketing.
As a small business owner, you wouldn’t necessarily consider marketing to be something that could get you into legal trouble, but recently, some small business owners have faced legal battles over text marketing practices that violate federal laws. One such example is of a local Long Island restaurant called Muscle Maker Grill. The restaurant was found to have sent 19 spam text messages to the plaintiff and ordered to pay $28,000 total in fines. For a small business owner, $28,000 could be a significant blow to personal finances if there is no protection in place. In this instance, neither the CEO nor the founder of the restaurant chain was named in the lawsuit because there was proper separation.
Similar text message marketing lawsuits name real estate brokerages instead of the specific real estate agent who sent spam text messages. While the real estate agent might face negative repercussions internally from the brokerage, their personal finances are protected in court.
3 Professional Liability Basics to Keep in Mind
Business owners of all sizes will want to take the proper steps to protect their assets by incorporating their business and getting liability insurance. There are several types of business formations that could protect a small business owner. While these won’t cover every possible lawsuit, they can offer a large amount of protection.
1. Form an LLC
A Limited Liability Corporation is the first and most basic step a small business owner can take to protect their assets. In some cases, you can still be held personally liable for actions your business takes. For example, if a personal injury was caused as a result of your business operations, this can potentially have negative legal consequences for the business owner — not just the LLC.
Importantly, if you form an LLC but continue to mix your personal finances with your business finances, you could be leaving your assets unprotected should legal action be taken against you.
2. Get liability coverage
Depending on the size of your business, there are several different types of liability insurance you can consider. You can get general liability insurance, which protects from injury or property damage claims; product liability insurance, which protects your company in case a product causes harm; or professional liability insurance, which protects against errors and omissions or malpractice.
General liability insurance might be enough coverage for you if you operate a small business. If you’re a consultant or freelance worker, professional liability insurance might be helpful even if your business operations are quite small. In fact, some companies require consultants to have professional liability insurance before they’ll enter into an agreement with them.
In some limited cases, you might be able to get away with using your own personal insurance instead of taking out additional insurance for your business. This could be possible if you have a very small business in its early stages. For example, if you have a small business that sells greeting cards at local farmers markets and you make these greeting cards in your home, your homeowners or renters insurance might cover the cost of replacing your materials if they were damaged due to a fire or flood in the home. In this case, you could possibly avoid having to purchase general liability insurance for your business. Check your homeowners insurance policy to understand the extent of what it covers. If the greeting card business were to grow into its own storefront, you’d likely want to proceed with general liability insurance.
You should consult your insurance agent for specific advice on when to buy liability insurance and how much of it to get.
3. Separate business and personal finances
Many small business owners use their personal finances to get their business started. It’s not uncommon for business owners to put expenses on a personal credit card in the beginning. If the business can reimburse your expenses right away, this shouldn’t be an issue. But if you’re using your credit card as a form of long-term financing for the business, then it could get sticky. It may be hard to keep track of what the business owes you if it’s mixed in with personal purchases (especially when the average American carries an average credit card balance of $3,546) and how it will repay this debt.
You can’t just transfer your personal debt to the business, even though you might have taken on the debt for company purposes. Once you sign your name for a personal loan or wrack up debt on your personal credit card, that debt is yours. If you are loaning the business money, make sure to do it officially in the form of a shareholder loan so that you can be repaid in the future.
One simple way to officially separate your finances if you’re in this situation and want to completely separate everything is to have your company get a business loan, which can be used to repay your shareholder loan. Once your business receives the funds from the loan, have it repay its debt to you out of these funds.
Make sure you keep the proper documentation of this process on hand in case of an audit. After the business has repaid its debt to you, stop mixing your personal finances with business and keep the two separate in the future.