Question: I’m a long time follower! Al, Hope you are well and in good spirits.

A client of mine started his own business in customizing web-based software for small, medium and large-sized businesses and non-profits.

It has grown considerably, and he is considering establishing an LLC or obtaining liability insurance. Could you point out factors (legal, financial, etc.) that might help him make a good decision?

Thanks so much in advance for all the help you provide.
 

Dan [Blog: blog.nesacs.org] Acushnet, Massachusetts

Answer: Dan, it is always a pleasure to hear from you!

In our personal and business lives, we all try to limit risks, and we all pay a lot of money to do so. That’s why we pay thousands of dollars of insurance premiums for automobile insurance, health insurance, homeowners insurance, malpractice insurance, and life insurance, to name a few. We also spend a lot of money to establish and pay annual taxes for opening up corporations (that is what “Inc.” means at the end of a company’s name), limited liability companies (commonly called an “LLC”), or limited liability partnerships (commonly called an “LLP.”) Each is an attempt to pay a reasonable fee in order to avoid a possibly unreasonable expense. 

When starting a new business, concerns about risk arise. Risks arise primarily from (a) unpaid creditors, and from (b) lawsuits based on liability, that is, harm from someone who is hurt due to alleged negligence. 

Limited Liability Company (“LLC”): A Limited Liability Company (often called an “LLC”) will protect your personal assets against both (a) and (b), above. That is because it serves as a “shield” or “veil” limiting both (a) creditors, or (b) liability litigants (such as a person who slipped on the floor) from suing your company, and stopping them from going after your personal assets. The protection afforded is unlimited; even if your company loses a lawsuit for a billion dollars, no one can go after your personal assets.

However, working through an LLC will not protect you against losing your new business, or your new business being hurt badly, if it is successfully sued by either (a) a creditor, or (b) a liability litigant.

Bottom line: an LLC is used to protect your personal assets from creditors and liability litigants.  It will not protect your new company, that is, your LLC, in any way.

Liability Insurance Policy: A Liability Insurance Policy, on the other hand, will protect both your personal assets and your LLC’s assets, if you use one, but only against liability lawsuits, such as someone who slipped and fell on the company’s floors.

A Liability Insurance Policy would protect your personal assets, if you were doing business personally, that is, without the protections of an LLC, an “Inc.” or an LLP, and it would also protect your company’s assets, if you were doing business personally.    

A Liability Insurance Policy is limited in its protections by the amount of the policy. Most small businesses maintain $500,000 or $1 million in coverage.

However, a Liability Insurance Policy will not protect you, or your company if you establish one against claims from creditors. If your landlord, or your telephone company, or your computer service sue you for unpaid bills, your Liability Insurance Policy will do nothing to protect you.

Bottom line: a Liability Insurance Policy will protect your personal assets and your business assets, but only from lawsuits based on liability, such as people who fall down. It will do nothing to protect your personal or business assets from claims of creditors.

Frankly, most people take both steps to protect themselves, and their businesses. First, they usually open up an LLC, an “Inc.,” or an LLP. This they do to protect their personal assets. Second, they usually purchase a Liability Insurance Policy, just in case someone “gets hurt” on their premises, or from one of their employees or trucks.

Those of us who are “professionals,” such as doctors, lawyers, engineers and the like, are not protected by either having an LLC or a Liability Insurance Policy, if we commit professional malpractice. It is for this reason that most of us maintain yet another “risk limiter”: malpractice insurance policies.

Risk – reducing it or eliminating it – is at the heart of so many choices we make, and objectives we seek.

Dan, I hope this helps. Again, it was so nice to hear from you.

         Best, Al Sklover  

© 2010 Alan L. Sklover, All Rights Reserved.