Starting a business, regardless of its size, marks the beginning of an entrepreneurial career that enables you to make money doing what you are passionate about. However, it also exposes you to various risks and liabilities.
There are risks involved in running any business. Your product could be rendered obsolete by superior alternatives; production costs could skyrocket or you could encounter crippling cash flow problems. Heck, bandits could even raid your store and get away with all the stock!
Some businesses are, however, riskier than others. Those that use hazardous materials, for instance, are considered riskier than say, a web design business. Other examples of high risk business include those that:
- Process and sell foods
- Serve alcohol
- Care for minors or animals
- Provide delivery or trucking services
- Provide sporting activities and adventures
- Repair and build motor vehicles and other consumer products
- Repair and construct buildings.
Although these enterprises operate in different industries, their activities or products can cause unexpected injuries to employees or customers. Those that manufacture consumer products face even greater risks, because substandard, non-compliant or faulty products could result in recalls. The story of Volkswagen is a perfect example of how product recalls can cost negligent manufacturers billions of money. Without adequate liability protection, a single mistake can put your company out of business.
So, how do you minimize the number of risk scenarios a business may face? How do you ensure its liabilities don't spill over to your personal assets? Read on.
Identify Potential Risks
The first step to shielding your business from liabilities is to identify all the potential risks it faces. In general, business risks are categorized into;
Strategic risks are tied to your business strategies and objectives. Investors who make poor decisions like starting a business without a solid business plan, hiring incompetent management personnel, entering an overly competitive industry or failing to effectively respond to market changes expose their enterprises to a loss of customers and, consequently, revenue.
Businesses are typically regulated by government agencies. Some industries, such as finance and banking, are heavily regulated, while others like e-commerce are less regulated. Evaluate the regulatory environment in your country and predict how future changes will affect your business. Regulatory changes can increase operating costs, introduce new technical standards for products, cap price margins or even make it necessary to obtain and renew licenses periodically. For example, if you run a payday loan business in a jurisdiction that does not cap the interest rates for such loans, there is nothing that stops the government from capping the rates in the future. Failure to comply with regulatory changes can expose the business to law suits and fines.
Operational risk is caused by events that can disrupt the day to day operations of your businesses, including fires, natural disasters, cyber-attacks, power outages, workplace injuries, breakdown of production machinery, security breaches and employee unrests. Some operational risks, like labor unrests, can lower production levels, while others like natural disasters can completely shut down a business for a long time. Either way, the company will incur unexpected losses.
A business needs a consistent flow of money to keep running efficiently. Cash flow disruptions caused by poor sales or defaulting customers can affect the ability of the enterprise to meet its financial obligations, such as settling debt and paying employee salaries. A financial risk can also be triggered by increase in interest rates in the credit market, stock prices and currency fluctuations. Excessive financial losses can push a company into debt.
It is never a sound practice to start a business in a politically unstable environment. Riots and civil unrests often force businesses to close down because property could be vandalized and looted by protesters. Even if you live and work in a peaceful jurisdiction that has never seen a war for decades, you can never rule out political risk. A change in government, political positions or foreign policies is enough to spark instability.
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Identify the Liability Associated with Each Risk
After identifying the potential risks your business faces, the next step is to determine the liability associated with each risk. What is the worst that could happen if, for instance, your rented premises catch a fire? Will your landlord sue you for an accidental fire? What if an employee falls down the stairs and breaks a leg? What if a customer develops an illness after dining in your restaurant? What if your business burns through borrowed cash and is unable to repay? What if hackers breach your online company and steal customer data? What if your manufacturing plant degrades the environment? Clearly, the “what ifs” can be endless.
We live an increasingly litigious world, so you are more likely to get sued for almost every claim that is thrown your way. It is only after identifying and quantifying your potential liability scenarios that you can be able to take appropriate measures to adequately protect the business.
Purchase Liability Insurance
Purchasing an insurance cover for the potential liabilities is the best way to protect your business. There are hundreds of products in the insurance market carefully designed to cover various businesses risks, from simple events such as computer failure to more complex ones like irregular financial reporting and cyber privacy breaches. Some large insurance companies can even evaluate your business conditions and design a customized policy.
Yet, small businesses walking a financial tight rope are often unable to purchase policies for every liability scenario. Many small enterprises only buy the insurance policies required by law, such as motor vehicle and employer’s liability insurance, and resolve to secure additional ones as the enterprise grows. This can be a fatal error, because you really never know when any of your possible risks will come knocking. If you lack the financial strength to buy cover for every policy, it is advisable to take up a general liability insurance plan. The cover will help to protect your company assets and settle fines, successful compensation claims such as employee medical costs and a range of other monetary and non-monetary obligations.
The amount of general liability coverage varies from businesses to business. Insurance companies charge more for high-risk businesses. They also consider the claims history of your company, as well as its location. Still, insurance may not be adequate in cases where liability claims are higher than the maximum coverage. For example, if an injured employee sues your company for $15,000 in medical costs and $5,000 in legal fees, and your maximum annual coverage is $10,000, you will need to dig into the company’s coffers to settle the difference. If the company doesn’t have the cash, you will be forced to use your personal resources.
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Create an LLC or Corporation
The most effective way to protect your personal assets in case of a claim is to create a limited liability company (LLC). An LLC can have one or more owners and must be registered in your state or country. Such a company protects all its owners from any form of liability exposure. If the company fails to repay debt, for instance, creditors cannot pursue your personal assets. Similarly, if the owner has personal creditors, they cannot claim assets registered under the company. In short, the company is recognized as an independent (legal) person.
You can also form a corporation, especially if you are a larger business. Just like an LLC, corporations are independent legal entities that are held responsible for their liabilities.
Hire a Risk Management Specialist
Some risks can be completely eliminated without having to purchase an appropriate insurance policy or register your company as an LLC or corporation. If you run an investment company, for instance, you can simply eliminate risk of financial loss by avoiding investing in risky or unpredictable ventures. However, without any professional training in risk management, you may be unable to accurately spot potential risks and take suitable mitigation measures. As such, it is important to hire an experienced risk management professional early on in the business, particularly if you run a high-risk enterprise. These specialists also come in handy during the purchase of an insurance plan, because they can use their expertise to determine the right amount of coverage the company needs.
As the business expands, you can also hire compliance specialists to ensure all the business operations comply with relevant government laws, and keep an eye on new regulations.
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This document is concluded between the Assignor, who is the holder of a Policy of Insurance and wishes to assign the benefit of the Policy to the Assignee.
Set Up an Asset Protection Trust
Asset protection trusts are ideal for entrepreneurs who have businesses with structures that don’t provide liability protection against personal assets. Although the effectiveness of trusts depends on how carefully they are constructed, they can protect your personal assets in case the company files for bankruptcy. Different jurisdictions have varying regulations for asset protection trusts, so you should do your research to find the territory that best secures your assets.
Whether you run a starting business or an established company with 50+ employees, it is crucial to take the necessary steps to not only protect the business from liability, but also your personal assets. Finally, don’t shy away from taking a risk just because it exposes you to liability. In the wise words of Richard M. Nixon, the 37th president of the United States; if you take no risks, you will suffer no defeats. But if you take no risks, you will win no victories!