There are several options when it comes to protecting your small business from losing everything to liabilities and lawsuits
I'm a software consultant regularly working with customer databases. If I were to accidentally delete a live database, the client could sue me for damages. What can protect me from losing all my personal assets in such a situation?—R.R., Lima, Ohio
Establishing a corporation or a limited liability company (BusinessWeek.com, 10/3/07) is a good idea for any business that has potential liability. It is particularly important if you are working at your clients' offices or sending your employees out to client sites, where they theoretically have access to proprietary information. "You want to put a firewall between your business activities and liabilities and your personal assets," says Bill Feldhaus, associate professor at the Robinson College of Business at Georgia State University.
Talk to your accountant or business attorney about whether you should incorporate, form an LLC, or take other steps to legally protect your personal wealth. There are tax and business consequences attached to the various options (BusinessWeek Small Biz, Aug./Sept., 2007), so you'll need personal counsel to determine which is most advantageous for your firm.
The Cost of Proving Innocence
You may also want to talk to an insurance broker about purchasing business liability insurance, which will cover your business costs if you are sued. "You do run considerable risk that something you've done could harm your client inadvertently. You could accidentally do something that permits a hacker to get into a client's system, or that leaves proprietary information open to competitors," Feldhaus says. There are some relatively new technology errors-and-omissions policies that are specifically designed for people who do IT consulting. You may be able to purchase one that provides up to $1 million in liability coverage for between $2,000 to $5,000 annually, Feldhaus says.
If you are sued, and it becomes clear that you or your company is at fault in the situation, you'd have access to insurance funds to settle the case rather than possibly having to resort to bankruptcy, says Robert Klein, associate professor of risk management and insurance at Georgia State. Even if you are sued and eventually cleared of any fault, it could cost $50,000 to prove you weren't liable and didn't do anything wrong.
"Even in cases where errors are alleged but not justified, you'd want to consider damages to your reputation as well as potential liability for monetary damages. Many professional liability insurers and policies are attuned to this, so they are prepared to pay for a legal defense when they might otherwise try to reach a settlement to avoid the risk of going to court," Klein says.
Preventing the Worst
He also recommends that you establish a comprehensive risk management plan for your company, where you identify potential risks in advance and take preventive steps to minimize them, such as doing advance testing on systems before you install them for customers. Richard Hagemeier, executive vice-president of Bolton & Co. insurance, outlines these risk management steps you might consider:
Limit your liability to a monetary amount by establishing the dollar size of your contracts.
Insert language into your service and software agreements that states you will not be responsible to your customers for any consequential damages resulting from their operations. "This could limit the potential business interruption loss that would be attributed to a significant loss of data by the customer," Hagemeier says.
Consider including in your contracts a requirement that your customers back up their data prior to your installation or servicing of their systems. "By adding this requirement, you may be able to eliminate the loss, or significantly reduce the loss [if it occurs]", he says.