Face Offensive Competition by Protecting Your Business
Every successful business is competitive in the market in which it is a denizen. However, competition is not rooted in defense; it is rooted in offense — as in sports offense and balance must be balanced. Reducing prices to beat competitors is an offense strike in the market but always comes with risks. Using cheaper products can expose potential customers to harm, while also exposing everyone in the chain of the product to liability. As a large corporation (abiding by corporate procedures), personal liability can be avoided or “shielded” by the veil of the corporation. As a home business operating as a D/B/A or in Proper Name you have no defense or “shield” to protect you from personal liability.
There are various types of business formations that can protect from personal liability but the importance of reducing the risks must first be explored.
Why Is It Important to Consider My Personal Liability Risks?
The first place to start is why. Every business is a snowflake. As such past experience is not enough; it is important to think of the liability in the current business. Below considerations will be given in the contexts of particular home businesses.
A home baker must take proper consideration of his risk. For instance, a home baker may inadvertently release salmonella upon consumers. A Notary working from her home may contain a hazard in her home which can cause injury to someone looking to use her service. Conversely, one who owns a private data entry home business exposes herself to little liability in most circumstances.
Proper considerations to the risks you could face will ultimately shape the type of business you should form.
Types of Business Formations
Generally speaking, there are four categories of business to form: personal businesses, partnerships, corporate businesses, and not for profit businesses. Personal businesses, who are owned by one person, are typically nominated as sole proprietorships. Partnerships are group owned businesses. True corporate businesses manifest themselves as C type or S type Corporations. A related corporate business type is called a Limited Liability Company. A not for profit business is commonly known as a “Non-Profit”. Each category will be explored according to the protection it affords the home-based business owner.
When Should a Home Business Owner form a C Corporation, S Corporation or Limited Liability Company?
C Corporations offer excellent shield to personal liability. In fact, the legal theory to sue an individual instead of the corporation requires herculean evidence to survive a motion dismissing the case. A corporation creates a “veil” which blocks personal suits. However, forming and maintaining a C Corporation is costly and complex.
Most home business owners are not personally familiar with how to file for a C Corporation and will need to hire an expert (a qualified attorney or online service) to file The Articles of Incorporation with the resident state. Also, a tax expert would also be recommended to properly file the C Corporation taxes. Many home businesses do not have the resources and time for this process. However, where home business owners contract with government or large corporations, for substantial sums of money, this option would be attractive to reduce personal risk.
S Corporations are similar to C Corporations but are not subject to as restrictive of tax measures, while also personally experiencing the flow through of profits and losses. Personal liability is also veiled as in a C Corporation. S Corporations require a small number of employees, which typically is not an issue for a home business.
The other corporate type of business is a Limited Liability Company (LLC). As with the S and C types, this business type should be used when the business experiences substantial profits. LLCs (not a Limited Liability Partnership) have specific tax requirements and filing requirements which should be explored with a professional. LLCs offer personal liability protection similar to formal corporations and are more affordable. However, localities must adopt laws allowing this business type, which again should be explored with a business formation expert.
When Should a Home Business Owner Form a Non-Profit Corporation?
An emerging business type is a non-profit corporation. Non-Profits (NP) offer excellent tax benefits to its members as well as liability protections. The excellent tax benefits come at the cost of using the business profits for a purpose other than enriching the Shareholders. However, for Non-Profits, liability can stem from two directions, internal and external.
The most obvious internal liability a NP faces is improper accounting of profits and wages leading to personal liability in the form of unpaid taxes or forced dissolution of NP by regulating authorities. Other internal liabilities, which lead to personal liability for a director, can include: a NP defaulting on a personally guaranteed loan, intentional fraud or reckless business conduct, or co-mingling of NP funds.
For the home business owner who wishes to have a place in the market and give back to her community with the profits (or another charitable purpose), a NP Corporation can be an attractive option. However, as in other corporations, corporate formalities must be abided which usually requires resources and expert advice.
When Should a Home Business Owner Form a Partnership?
Partnerships are a flexible business type which offer some liability protections if crafted appropriately. Partnerships which limit liability are restrictive by many factors but can include the business type, type of partners involved, or the locality in which it will be formed.
A Limited Liability Partnership (LLP) in many ways is similar to a LLC. There is one key exception. In a LLP one member, managing member, can be personally exposed to liability. If other members or partners take on a managerial role, they too can be exposed to liability. In many, but not all localities, LLPs can only be formed by the denominated business types. For instance, in the United States of America, State of California, only lawyers, accountants, or architects may form LLPs. If your home business has little exposure to liability and may form a LLP, a LLP is a great business type as it offers LLC-like tax benefits and shields exposure to liability to all but the managerial partner. For example a family owned architecture business, which operates as a home business, could greatly benefit from this business type.
Other types of Partnerships are similar in form but are less formal and require less to properly form the business type. The sculpting feature to Partnerships is that there is at least one member whom can be personally liable for the actions of the business. Money partners (also known as silent partners) are typically not personally liable for the actions of the business.
In general, Partnerships offer less personal liability protections than do corporate business types. If operating as a Partnership identify your liabilities and be vigilant in guarding against them. Also, be prepared for the worst-case scenario as a Managing Partner and save some profits to pay for attorney fees and/or settlements for future personal liabilities.
When Should a Home Business Owner Form a Sole Proprietorship?
A sole proprietorship (SP) is the simplest and most cost-effective business type to form. A SP is done in the name of the person who owns the business or in a doing-business-as (DBA) name. Local laws will govern what type of basic filings must be done to register the business. The gravamen found in most tax audits is improper accounting of profits and unproven write-offs. As there is no business to pay taxes, taxes must be paid personally and accounting must be extremely organized.
A SP or DBA should not be the long-term goal of any business. A SP or DBA offers no insulation but rather should be viewed as a way to test the market without committing serious funds or resources into a business venture. The risk for personal liability floats on the surface so as soon as one can commit to a more formal business type this should be done.
Balancing Personal Liability with Resources
By projecting into the future and crystallizing future risks, one can properly form the right business type. Home business owners who realize smaller profits and have limited resources should consider starting as sole proprietorships and eventually forming a type of limited partnership.
Home business owners who work for a cause and want excellent tax benefits at the cost of realizing business profits should form Non-Profit Businesses.
Lastly, home business owners forming a profitable business with ample resources should form Limited Liability Companies with the intention of eventually transmuting the LLC into a S Corporation or C Corporation.
As with all complex matters in life or business ensure the help of a professional is there to guide you through your options, because the best offense in a competitive market is often having a good defense to protect against personal liability.
