I'm starting a business and wondering how I can protect my personal assets. Any nuggets of wisdom would be much appreciated.
—L.A., Muskogee, Okla.
First off, be aware that entrepreneurs typically put some assets on the line—and if the business fails, they don't recover everything. But there are ways to minimize your risk, starting with forming a legal business entity that provides liability protection.
Many small businesses begin life as sole proprietorships, which are easy and inexpensive to establish, but don't protect the owner's personal assets in the event the business is sued or goes belly-up. "In a sole proprietorship, the entrepreneur is the business, and all of the entrepreneur's assets are business assets," says Bradley A. Haneberg, an attorney at Kaufman & Canoles in Richmond, Va. The same is true of a general partnership, which two or more partners might form. A more specific option such as a limited partnership might give passive investors some freedom from liability, but general partners would still be on the hook, he says.
To better protect your personal assets, you (and any partners you might have) should consider forming a corporation—either a C Corp. or an S Corp.—or a limited liabilty company or LLC, Haneberg says. Talk to an accountant or a business lawyer about which structure is right for your company. You'll want to consider some important tax consequences. A C Corp., for instance, is a completely separate entity that pays its own taxes, while an S Corp. is a "pass-through" entity, meaning the profits are listed on the owner's income tax returns and taxed at the individual rate. An LLC, much like the S Corp., combines pass-through tax benefits and protection from personal liability, but operates in a less formal manner than a corporation. That may be attractive to an entrepreneur who, for instance, wants "some additional flexibility in structuring business relationships between investors," Haneberg says.
While choosing the proper form of incorporation is an important step in protecting your personal assets, you'll also want to call your insurance agent—something many startup entrepreneurs neglect to do, says C. Dickinson Hill, a business attorney in Los Angeles. "Many business risks can be adequately insured against," he says. For instance, if you're using your personal auto for business purposes, consider a rider that covers business use of your personal vehicle. "You'll pay a little more, but it's worth it," he says.
Even if you take the steps we've outlined here, it's likely that you'll be asked by a landlord or banker to personally guarantee some contracts for your startup, says Alan Gutterman, a partner at The General Counsel, which provides interim legal services to companies. If you do have to sign a personal guarantee to lease an office or get a loan, negotiate for limitations on the amount you'll guarantee and for how long, he advises.
Lastly, common sense can help you limit risk, suggests Clifford R. Ennico, a small-business legal expert in Fairfield, Conn. "When dealing with new clients and customers, trust your gut instincts," he says. "If the people seem irrational, off-balance, or difficult in any way, tell them you're too busy to work with them and refer them to someone else—preferably your worst enemy."
Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.