How To Minimize Your Business Risk

You've started up your business, things are moving along, and you've taken the step -- or are about to -- of organizing your business into a legal entity. You know the pros and cons of organizing as an LLC vs S-Corp vs C-Corp etc. from watching our last episode "LLC or Inc?".

You also know how these legal entities can protect you and your business in the event of a lawsuit, wrongdoing on the part of a partner, or other unforeseen and unfortunate circumstance.

But just having the shield of an LLC or Corporation isn't enough to protect you and your interests. Where a legal entity leaves off is where things like service provider agreements and business insurance pick up.

Special guest Matt Simmons, Esq., a partner with business and employment law firm Shepherd Law joins our show today. Matt talks to Pamela about the ways you can minimize the risks you face as a business owner, from both inside the business and outside of it. We cover operating agreements, what level of protection you can expect from each type of business entity, and of course, business insurance: when to get it, what it should cover and from whom you should seek it.

Leave us a comment with your experiences and let us know if this episode has been helpful for you!

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Video Transcript:

Pamela:    Hey everybody it’s Pamela and welcome to another episode of How Business Really Works.

[Music]

Pamela:    So I have a special guest with me today Matt Simmons from Shepherd Law.  They do business and employment law.  Tracy isn’t here as you noticed.  She is working on the website and getting some other things done for you guys that’s going to be really good.

And so I have the special guest here today to talk about how to mitigate risk in your business when you are incorporating and then even after that when you are just the daily operations of your business.

Matt:  Thank you for having me.  I appreciate it.

Pamela:  You’re welcome.  I almost cut you off.

Matt:  That’s fine.

Pamela:  So last week Tracy and I did an episode about whether you should get an LLC, whether you should be an S-corp. a C-corp.  If you are looking at organizing your business legally what is the best business structure for you? And we went over a lot of things; taxation, paperwork, stuff like that.

One of the things we talked about is personal liability and we kind of lightly glossed over how to mitigate your risk.  How different business entities will help you mitigate your risk depending on how you incorporate.  But we really wanted to delve more into that so this is all about going deeper into how to mitigate your as you incorporate and afterwards.

So some of the risks we identified last week were things like tax penalties if you don’t do your paperwork on time or don’t follow up every year with your paperwork, personal liability in case you are sued, personal liability in case your partner does something wrong.  What other kinds of risks Matt, are we look at?   I mean those are some but you have been in this field so you know a lot about, you see a lot of things.

Matt:  Well those are all good points and those are all things business owners need to worry about when making such determinations but some of the important risks one needs to consider aside from those are how many partners you are bringing on.  What the partners bring to the table.

I mention that because if you are going to be a limited partnership or an LLC with just one other partner, are you both contributing equal amounts of funds? And if so, what’s that mean for the business?

So one way you can mitigate certain risks associated with that, and I am sure you are familiar with something called operating agreements and bylaws?

[Time – 2:30]

Pamela:  Absolutely.

Matt:  The difference between the two is an operating agreement is used for an LLC whereas bylaws are used for a corporation.  And what they do is they kind of lay out the rules, the roles, the responsibilities, and the various other necessities with the business that prevent certain things from occurring.  And that helps mitigate risks.  I use that as an example because I believe one of the things you want to discuss is something called piercing the corporate veil and I am sure we will cover that in a little bit.  But that’s one of the things it can prevent. They can also prevent someone trying to usurp or steal the company’s assets to the detriment of the partners and it also makes it seem more formal in the eyes of the government or the state.

Pamela:  A C-corp.?  Articles of Incorporation?

Matt:  Those as well as the bylaws.

Pamela:  The bylaws. Okay got it.

Matt:  Now some of the other risks associated with a corporation operating a business is what happens, as you mentioned if they get sued?  Who’s going to be responsible?  Who’s going to be left holding the ball?  There is something called “acting in the course of your employment” or “acting in the course of the business”.  So if you have a partner or an employee that is acting in the course of the business, the business will be exposed.  However, if you have one of your partners or one of your employees, it says takes the company car and goes to the track and blows a lot of money and then gets upset and hits someone, he is not exactly acting in the course of the business.  So how does that leave the business at the end of the day?

Pamela:  We did touch on that somewhat last week but it is interesting you put it that way.  So one of the things we talked about was if I go, I have a cleaning business.  This was our example last week.  So if I have a cleaning business and my employee goes to somebody’s house and breaks something valuable, then they as the employee are liable and I am also liable as the business owner.  Is that correct?

Matt:  I’m going to give you the standard lawyer answer.  “It depends”.  It depends because one way you can mitigate that risk is by putting together an agreement that you have with your customers.

Pamela:  Okay.

[Time – 5:00]

Matt:  That says you know if they break something, you or your employees are not liable for it if it was not done purposefully or so and so forth.

Pamela:  Okay

Matt:  There are certain ways you can mitigate most if not any risks that arises in the course of acting in business regardless of what the business does.

Pamela:  So two questions.

Matt:  Yeah?

Pamela:  If that employee were not acting in the course of the business?  Not doing her, his or her business duties as my cleaning person, then and they broke something at a client’s house, I don’t know why they would be at a customer’s house if they weren’t on the job, but in some hypothetical let’s say they were, but they weren’t there to do the work then I could not be liable if it was not an actual business job?

Matt:  Correct.  Or a more succinct example would be like if the employee was drinking or on some substance.

Pamela:  That’s a better example.

[Time – 6:00]

Matt:   Yes, you know, is acting outside or not performing their job in the best interest of their employer, as long as the employer didn’t have knowledge that this person had a problem.  And did not hire this person or continue to employ them negligently.   The business would not likely be liable.

Pamela:  Okay so my second question is, say I put one of these agreements in place with my customer that sort of mitigates my risk in case of anything like that happening.  How enforceable are those?

Matt:  Well as long as you lay it out such that it doesn’t have any unconscionable provisions, is what we call them legally.  And what that means is, “if they are not so one sided”.  An agreement cannot so one sided.  An agreement has to bring certain things to bear.

It has to have something called “the meeting of the minds” whereby the company, in this case, the company and the customer agree on the same terms.  It has to be definite as to price, time, what is being delivered.

Obviously, it has to be signed or agreed upon by both parties, usually in writing.  And there are some forms of agreements that will not hold if it is not in writing.  An example is a real estate contract.  You can’t have an oral real estate contract.  You also can’t have an oral agreement that lasts for a period of longer than one year.

Pamela:  Ah, I didn’t know that, interesting.

Matt:  Yeah, and lastly, there has to be something called consideration.  What that mean is that is a fancy term saying “I’m giving you something and you’re giving me something”.  So you pay me fifty dollars, I clean your house.  That’s consideration on both sides.

Pamela:  Right, an equal exchange.

Matt:  Correct.

[Time – 7:47]

Pamela:  Okay, great!

Say the worst happens, and I am being sued for some mishap during the course of business that my employee did, she broke something or he broke something, they are not drunk, it just happened as an accident, and now I am liable for that.  Is there a business entity that gives me more or less protection for my personal assets?  Now we are just talking about my own, my car, my clothing, anything that I own personally.  What kind of business entity is the best for that protection?

Matt:  It’s an excellent question because, across the United States, the most common form of business is just a partnership or just a general partnership or a limited partnership.  Now, unfortunately, sometimes those don’t need to be filed with the state.  They afford no protection such that if your company gets sued they can come after you personally as well as your business partner personally.  So I don’t recommend using any type of partnership per se.  With respect to increased levels of protection, there are certain organizations you can form.

One is called the Limited Liability Company.  What that does is it sets apart the individual or individuals from the business.  So in your example, if the business gets sued for something an employee does or something someone acting on behalf of the business does, the corporation or limited liability company in this instance will get sued, but the individuals owning that business cannot be attacked their personal assets.  So essentially only the assets that the company owns can be used to pay or used to completely cover a judgment that is entered against the company.

Additionally, another thing you have to, you need to make sure you do regardless of what business entity you have is you need to get business insurance.

[Time – 10:00]

Pamela:  Yes, yes.

Matt:   And I’m sure you want to discuss that.

Pamela:  Yes we will talk about that momentarily.

Matt:  Yes, but in addition to an LLC there’s also, as you mentioned, various forms of incorporation you can do.  There is something called a C-corp. and there is an S-corp.   Now there is a difference in the two but it doesn’t relate to protection per se.  It relates more to taxation.

Pamela:  Okay it is more taxes, right, okay.

Matt:   But any filing, any company that is officially filed with the state.  Limited Liability Company, S-corp., C-corp., and then professionals, there are various professional organizations that you can form, like a PA or an LLP or something like that, those form protective layers for recognized professional such as CPAs, attorneys, doctors and various other professionals, but the easiest, cheapest, and most straight forward way that affords protection to people is an LLC.

Pamela:  So am I getting the same liability protection in an LLC that I would get in a C-corp.?  Are they all equal in that regard?

Matt:  From the example you set, yes.  More complex things with respect to shareholders suits and stuff like that.  That’s a little complex, and that’s not really going to arise that frequently, but as it pertains to strict liability for you know an accident that occurs, yes, they both afford the same levels of protection.

Pamela:  So speaking of personal assets, as I understand it, if you own shares, let’s say you have a C-corporation, and you obviously own shares in that as one of the owners, those are considered personal property.  Is that correct?

Matt:  That’s correct.

Pamela:  So if I get sued what happens to those shares?

Matt:  If you personally get sued?

Pamela:  Um Hmm

[Time – 11:57]

Matt:  If you personally get sued what can happen is you have something called tangible and intangible assets, and both can be used to cover the judgment that is entered against you.  So you can have your house which is a tangible asset and you can have physical money which is a tangible asset.  You can also have shares in a company which is a tangible asset.  Various other things like intellectual property.  Those are intangible. Those are all; those all have an inherent value.  And essentially the person that gets the judgment against you has the ability to determine what assets you have and garnish them, which can include those shares in the corporation.

Pamela:  Okay and in that event, then my partners if I have any, or other shareholders in the company are now in business with this new person that they may not know, may not like, may not know how to do business with.  So is that a real risk?

Matt:  It’s a risk if you own a majority of the shares of the corporation particularly, because if you own a controlling interest in the company, you are personally sued, and those shares are given to someone else, yes that is a risk; however you can mitigate that risk by putting your shares in the; under the ownership of a separate company or a LLC.

Pamela:  Oh, interesting.  I didn’t know that.

Matt:  Yes, so…

Pamela:  Learning all kinds of things today.

Matt:  Well, I try. But yes there are certain ways you can protect that as well, yes.

Pamela:  Can I create an LLC just for that purpose?  Or does it have to be an actual business that’s conducting business?

Matt:  It does not have to be an actual business.  You can have something called a holding company that essentially owns the assets of a company and… This is one of the reasons people hate lawyers.  It’s because we have way of kind of getting around things

Pamela:  Getting around things.

[Time – 13:57]

Matt:  But the way you can structure it is such that you have a company that is built for the purpose of cleaning houses. You have a company that sells bagels. You have a company that owns a bubble gum factory.  And all their shares, all the assets of these companies, each of these individual companies can be owned by something called a holding company.  Such that if any of these underlying corporations or companies are sued, they have no assets.

Pamela:  Interesting, and that is perfectly legal?

Matt:  Perfectly legal.

Pamela:  I’ll have to keep that in mind.  Not that I plan on doing anything wrong but you never know.

Okay, so you know I’ve heard of holding companies before.  I mean we’ve all hear that term but I never knew what it meant, interesting, okay.

Matt:  And it adds a second layer of protection and it makes it more difficult for individuals, companies or aggrieved parties to attach the assets of a given company.

Pamela:  Okay, so that brings up another question.  And we’re actually going to get into; it’s kind of a two part question now, now that you’ve said that.  First part is: How easy is it to pierce the corporate veil?  So we mentioned that term earlier.  Piercing the corporate veil, when I’ve spoken about that in the past, I wasn’t really thinking of a holding company.

So let’s talk about what piercing the corporate veil is, how easy is it to do, and if I do have a holding company does that complicate things?  If a judge is trying to pierce the corporate veil and let’s say they find me guilty of you know, using my business to fund my gambling addiction and I am found guilty of that, having a holding company, does that add a layer of complexity or difficulty?

Matt:  The more complex and the more legitimized you make your business; the more difficult is it to do something called, pierce the corporate veil.  What that means is essentially that they are trying to determine that the company and its individual members are one in the same.

[Time – 15:58]

Okay, so the way someone or the reason someone would try to do that, for example, is let’s say, to use your cleaning business example, let’s say it’s an LLC, it doesn’t have a separate banks account, just uses my same bank account, all the monies that come into the company are paid out directly to me and various other things were by the company is not really the company.  It’s just me incorporated.

Now, what if myself or one of my employees were to get into a car accident and the general liability policy wasn’t going to cover that, then the aggrieved party, the plaintiff, in that case, would try to come after the individuals.  So they would file a motion seeking to pierce the corporate veil and essential hold that the company and its individual owners, i.e. myself are one and the same.  And in that instance, my personal assets would be subject to encroachment, garnishment, and levy.

Now there are ways you can avoid that too. Just to keep that example simple, with respect to an LLC, if the LLC is operating pursuant to its required; the requirements under the corporate code established here in Georgia for example, then it makes it more difficult to do that.  I mentioned earlier an operating agreement for an LLC and the bylaws for a corporation.  When you have those in place and insure the company is acting pursuant to them, the company will be viewed as separate from its owners, more likely than not.  So that makes it more difficult.

[Time – 17:48]

With respect to adding a layer of complexity, you mentioned a holding company, even if they do pierce the corporate veil with respect to the companies, in the instance of a holding company.  So you’ve got the various companies here, and all the assets are owned by the holding company.  So what they will try to do is get up to the holding company to get the assets.  The layers of complexity you can add there with respect to the agreements between the parties, the separation between them and the separation between the companies, makes it incredibly difficult to do so. So the more apart you can keep things and the more distinct you can make the individual companies the more difficult it becomes.

We’ll use General Electric for example.  General Electric is a company that has, it’s a multi-national, multi-faceted company that has; you know they own General Motors. They have other, they own TV companies, they own production companies and they all are individual companies but they are all owned by General Electric.  So that is the holding company essentially, or the parent company if you will.  But when you get into that complex relationship, that’s where it makes sense.  But just to keep things simple in that LLC example, so long as you set up a business account, you have an operating agreement in place, you keep things separate, you have a separate mailing address, separate registered agent, so and so forth.  That helps prevent that risk of piercing the corporate veil.

Pamela:  Great, okay.

So we’ve gone through all the possibilities of how to protect your business, protect yourself.  Setting up a holding company if that makes sense if the complexity of your business is high enough.  And things you can do to make sure you are operating your business as a business and not as your personal bank account.  But there are still some gaps in your protection and that is where insurance can come in.

Matt:  Yes.

Pamela:  So let’s talk about a good business insurance policy, you mentioned that earlier.  When should I get one?  What should it cover? Could you set that up as my attorney or do I have to go to an insurance sales person?  All these questions.

[Time – 20:03]

Matt:  Well you should get it before you start your business.  You never want to be uninsured as a company.  Because honestly certain, like if you are going to lease a space to operate your business, they require that you get insurance.  But you know it’s never a good idea to not be insured as a company.

Now there are various forms of insurance. The most basic and most obvious is just a general liability policy.  What that is it covers the business, anything that happens in the course of the business.  You know if you have one of your employees gets in an accident, it covers that.  You know your product, as we call it in lawyer land “widget”; you know it is just a general term…

Pamela:  We do that in IT too.

Matt:   it malfunctions, or causes damage in some way, shape, or form.  That is something you can turn to.  So that is your basic policy.   Additionally, you want to have something called business interruption insurance.  What that means is, you know if you run a factor or you’ve got a store outlet and a tornado comes through or you have a pipe burst then your operation or your outlet is destroyed or needs work and you can’t run your business, you’re obviously losing money.  So what a business interruption policy provides and protects against is that downtime you have and it’ll actually cover your revenue stream for a period of time while you are down.

Pamela:  Okay.

Matt:  Also people that are professionals, such as myself, doctors, CPAs, needs something called errors and omission.  E&O insurance covers if you do something that’s a mistake or something that’s considered to be malpractice that someone sues on. Errors and omissions you can look to that as a way to protect against it.

[Time 22:05]

Additionally, certain other insurance things you can have, you can basically have insurance for anything.  Now it’s a cost-benefit analysis you need to run as to how much a) you need covered, b) how much do you want covered and c) and how much money do you have to spend.

Pamela:  Right, how much will it cost?

Matt:  Now this is something you should definitely consult an attorney about first.

Pamela:  Okay.

Matt:  Because they can give you an idea. But that insurance needs to be procured through someone that actually has the ability to issue policies.

Pamela:  Got it.  So the types of insurance you mentioned are basic liability coverage, business interruption coverage, error… what was that called?

Matt:  Errors and omissions.

Pamela:  Errors and omissions, so that is sort of a malpractice coverage.  Anything else you can think of?

Matt:   Yeah, I mean, you can get pretty much anything and everything.  You know if you are operating a business and you have three or more employees you absolutely need to have something called workers compensation insurance.  Cause if you don’t have that, and I have a client right now that is going through that scenario, you can get sued not only by someone that gets injured while they are working for you and doesn’t have coverage; but the state will also bring criminal charges against  you because it’s a requirement, yes, that you have it.

Pamela:  If you have employees?

Matt:  More than three employees, correct.

Pamela:  So less than three employee or just partners in the business you don’t have to worry?

Matt:  No, partners you don’t have to worry about.  If you have actual people that are employed as employees; and  that’s another..; I think goes beyond the scope of what we are discussing today, but you might want to do an episode in the future about the difference between a classification of an employee versus an independent contractor.

Pamela:  Yes, yes, and I’ve been both.  I’ve been a 1099, I’ve been a W-2 and I know there are big differences in terms of what the company can require of you and how you are covered.

[Time – 23:59]

Matt:  And there’s big risks as well, not only associated with classifying someone as an employee or an independent contractor but also the issue of mis-classification is becoming extremely hot button issue in the legal forums.

Pamela:  Yeah that’s true.

Matt:  So, but yeah you can get insurance for anything and everything.  You know there are football players out there that insure their legs or their body in case they get injured.  I believe it was Tina Turner that insured her legs for like ten million dollars or something.

Pamela:  She did have nice legs.

Matt: Yeah, she did, but that being said insurance can and will cover anything.  But the basic policies a business owner needs to consider is a general liability, possibly an errors and omissions, business interruption insurance and then workers compensation insurance.

Pamela:  Okay.

Matt:  It might be dealt with on a state level because for example there are things insurance companies are allowed to do in Georgia that they are not allowed to do in California.

Pamela:  Ah, okay.

Matt:  You know so it’s a state by state case, ruling, and that’s why each insurance policy says it’s governed by and operates pursuant to the laws of the state in which the policyholder resides.

Pamela:  So if I incorporate in a different state, I would still have to get insurance in this state?

Matt:  Correct.  Any state you are operating in, you need to get a) insurance and b) you need to even if you are incorporated in say California for example if you are doing business in Georgia, you need to incorporate as a foreign company doing business in Georgia.

Pamela:  That’s right and I do cover that, we didn’t mention it so far, but I wrote an eBook about this; just updated it for 2017.  We did mention it in our last episode but I’ll just give myself a plug.  In case anyone is interested in this eBook, I’ll put a link in the description, but it is all about forming an LLC or an S-corp. or a C-corp., all these business entities and what they can do for you in terms of taxation, or what they won’t do for you; personal liability, management, paperwork, and incorporating as a foreign entity is also covered there.  And what you can expect or not expect if you are operating in one state; incorporated in one state and operating in another.  So I’ll put the link to the book.

[Time – 26:20]

Any parting thoughts about insurance or just how to operate my business so that I’m at least minimizing my exposure?

Matt:  Parting thoughts in terms of that Pamela is you asked, you know, there’s a lot of risk as a business owner.  And we’ve touched on a few, but if you want to fully understand this, I think you should check out Pamela’s eBook which will definitely help and if you would like to discuss this further go see your family lawyer, see me, it doesn’t matter.  Just seek out any help and try to be as informed a consumer as possible.

Pamela:  I agree.  And it is important to note that even though I did write an eBook and I put a lot of research and thought into that, I am not an attorney, and so my advice and even this show, it should not be taken as a substitute for getting legal advice and getting legal advice in advance before anything goes wrong.

So definitely want to check out a CPA, an attorney, a financial advisor wherever you are at in your business.  You need, you do need the expert's input.  We are here to help you.  We’re here to guide you and just kind of get you going in the right direction, but the rest you’re going to have to consult with the actual experts that do this for a living.

Matt:  And that was a superb point Pamela because I believe that, from my viewpoint, every business owner should have three people they seek out; is a financial planner, a CPA, and an attorney.

Pamela:  Agreed.  Thank you, Matt, this has been wonderful.

Matt:  My pleasure.  Thank you for inviting me.

Pamela:   I have really enjoyed this.

Matt:  I appreciate it.

Pamela:  And now can you tell people where to find you if they want to look up your law firm or just see what your work is all about?

[Time – 28:00]

Matt:  Absolutely, again my name is Matt Simmons.  I’m a partner at Shepherd Law here in Atlanta Georgia.  Our website is http://www.shepherdlaw.net.  My profile’s on there.  Just a little bit about me.  I’ve been practicing law for this is my tenth year.  It’s a little scary.  I’m president of a local bar organization here called The Atlanta Council of Younger Lawyers and I’m primarily a litigator, which means I’m the guy that argues in front of the court.  My partner Tom is primarily a transactional attorney which means he puts together these agreements I was talking about such as holding companies and everything like that.

But, I would love it for your viewers to reach out to me.  Ask me any questions they may have.  And aside from most, what makes us a little bit different from most of the people that are in our practice area, is that our initial meeting with people we charge absolutely nothing.

Pamela:  Oh, I did not know that.

Matt: Yes.

Pamela:  Alright, great.  Thank you again.  And for you that are either listening to the podcast or watching this video, please feel free to participate in the discussion.  Leave us comments below if you are watching on YouTube and send us your feedback if you are listening on the podcast.  We would also really appreciate it if you would give us a review.  Let us know if this episode and any of our previous episodes have been helpful for you, if you’ve learned and your business has grown and moved forward because of the content we are bringing you, we’d really appreciate your feedback.

So don’t forget to participate, get in touch and subscribe.  See you next time.

[Music]

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