Theft. Injury. Natural disasters. Market shifts. Whether you are a new business owner or a seasoned one, risk management is likely at the forefront of your mind when considering how to protect the business you’ve worked so hard to build. Some risks (theft and injury, for example) are internal to your business while others (market shifts or natural disasters) are external risks or threats. You have lots of options when deciding on the best risk management strategies for you and your business. The purpose of this article is to help you make informed decisions when it comes to managing the risks of small business ownership.
Which insurance is best when considering the risks of small business ownership?
Small business insurance options help to protect your property and income against liability claims, damage from accidents and errors, injuries, natural disasters, and more. It’s likely you’ll need more than one insurance type in order to cover all the risks of small business ownership.
Basic coverage
In general, it is suggested to at least have general liability insurance. This protects businesses from lawsuits and third-party claims, major risks of small business ownership. It also protects against property damage and injuries that are the fault of the company, legal expenses, and certain damages to a company’s rental properties such as fires. False advertising claims such as slander and copyright infringement are often covered as well. Most small businesses pay between $400 and $800 a year for this coverage. Business owner’s policies (BOP) provide bundles where you can customize options in a more cost-effective way. BOP is a good option for lower risk businesses. While the needs of every business will be unique, below are some suggestions for how businesses in different industries might benefit from certain coverage.
Industry based suggestions and costs
Commercial auto insurance
Commercial auto insurance provides liability and physical damage protection (theft, vandalism, or other damage) for vehicles used by a business. It covers accident-related medical bills, collision, comprehensive coverage, and uninsured motorists. Most states require utility vehicles to be covered by commercial auto insurance. The average costs for this insurance are between $900 and $1200 per year for $1 million dollars in liability. Good candidates for this insurance are construction and contracting, landscaping, and real estate. Commercial truckers need to use a special group of insurance as mandated by the Federal Motor Carrier Safety Administration (FMCSA). Owner-operators or small trucking businesses will find a variety of options depending on the type of truck, what they carry, and other factors. All commercial trucks are required to have at least $750,000 in coverage and owner-operators are encouraged to get a general liability commercial trucking plan.
Worker’s compensation
Worker’s compensation is a type of insurance that covers your employees if they are injured while working. They receive wage compensation for their time out of work during recovery and also medical benefits in exchange for agreeing not to sue the company. All companies with payroll employees (all employees who are not independently contracted) are required to offer worker’s comp. The cost of worker’s compensation will depend on several variables including your state, your industry, your annual payroll, and your history of workplace accidents. Higher risk industries for work-related incidents will have much higher premiums but should also be the most serious about having worker’s comp as this is a risk of small business ownership that increases as you hire more people. Construction and contracting businesses could be looking at about $3,000 a year, landscaping around $2,500, and cleaning services about $1,800. Low-risk industries like finance can cost around $400.
Professional liability insurance
While worker’s comp covers physical injuries to your employees, professional liability insurance covers financial injuries to your clients. This includes any harm caused by employee negligence, missed deadlines, mistakes, and undelivered services. It covers legal costs and any settlements generated by a client’s claim. Businesses who offer professional services or advice to clients or who are in a contract with a client should consider professional liability insurance. Good candidates include consultants, engineers, attorneys, and auditors. Insureon states that many small businesses pay between $500 and $1,000 a year for professional liability insurance.
Employment practices liability insurance (EPLI)
Employment practices liability insurance (EPLI) covers a variety of employee claims, including but not limited to: sexual harassment, discrimination, wrongful termination, and wrongful discipline. All legal fees related to claims of employees’ violated rights are covered by this insurance. Premiums, as always, depend on location, industry, business size, and other variables. Businesses can get EPLI endorsement through their BOP for as low as $300 or pay for a standalone policy from $800 to $5,000 a year. Prime candidates for EPLI are medical practices, manufacturing, professional services, retail, and foodservice.
How should you file your small business?
In the interest of mitigating the risks of small business ownership, choosing your business structure will have a major effect on operations, taxes, and protection. It’s important for you to make the right choice for filing based on the unique needs and goals of your business. We will focus mainly on LLCs and sole proprietors.
Limited Liability Company (LLC)
Filing as an LLC is good for medium to high-risk businesses. You are only liable for the amount invested in the LLC while a sole proprietor is liable for all debts of the business. To satisfy those debts, creditors can take your home, car, and other personal assets. It is also easier to obtain financing as an LLC. There are additional taxes and industry state fees to pay but it is often worth it for the liability protection and credibility it gives you in the market. While fees in the US range between $50 and $500, the average is $127. Aside from the cost, one disadvantage may be that, in some states, LLC’s are required to dissolve and re-form with new membership every time a member leaves or joins, unless otherwise stated in an existing ownership agreement. Even with the protection of this filing, an owner can still be in danger of personal risk so it’s important to have insurance in addition to the protections provided by LLC status.
Sole Proprietor
The biggest difference between filing as an LLC and a sole proprietor is that, as a sole prop, your business assets and liabilities are not separate from your personal ones; you have complete control but you are also at risk of losing everything in the face of debt and business obligations. The lower cost is one of the main benefits. The costs of filing differ by state but are usually very low ($10 to file in Texas). There are no annual filing fees or state paperwork and no additional taxes (though you do have to fill out additional tax forms). There are also tax write-off benefits similar to being self-employed. This can be a good option when a business is just starting out and wants to test the waters with the intention of incorporating later. It’s best for low-risk businesses and would most likely be an unwise choice for mid to high-risk businesses due to the threat to your personal assets.
Other filing structures
While most small businesses will either file as a sole prop or an LLC, businesses with more than one owner may consider filing as a partnership. This can take the form of either a limited partnership (LP) or a limited liability partnership (LLP). As with the sole proprietor option, this can be a good way to test the waters before incorporating. Filing as a corporation, or C corp, is better for bigger businesses. They offer the strongest protection against personal liability but they are also more expensive to maintain with more demands on reporting and operations regulation. They are also required to pay income tax on their profits. Sometimes they are taxed a second time when dividends are paid to shareholders. S corporations avoid this taxation issue by side-stepping the corporate tax rate on some profits and losses. They do this by passing some profits, deductions, and credits on to shareholders for federal taxation.
There are a handful of other options for filing but if you ever plan on seeking financing or scaling up and want to protect your personal assets, LLC is a good option.
How do you manage employee risks of small business ownership?
While employees add value to a company, they also pose a risk in major areas. Employers can mitigate these risks with the above-mentioned insurances and also by being committed to following federal guidelines and best practices.
Employers’ responsibilities
Be sure to comply with Occupational Safety and Health Administration (OSHA) standards in your workplace. Ensure that the workplace is free from hazards and that there are clear warnings for potential hazards. Keep operations procedures updated and make sure to communicate them clearly to employees. This goes for physical equipment operations and any technological or security-based operations. Pay employees fairly and provide them with a statement for each paycheck detailing any deductions or withholdings. Each state will have its own labor laws regarding paying employees so make sure you are in compliance. It is also important to consider equal opportunity requirements in hiring, pay, promotions, and benefits, especially in regards to gender (see the Equal Pay Act of 1963), race (see the Civil Rights Act of 1964), and disabilities (see the Americans With Disabilities Act).
Employees as a liability
If an employee provides costly misinformation to a client or does questionable work, this could generate a most unwanted lawsuit. This is one reason you’ll want professional liability insurance which can cover mistakes made by employees. In the hiring process, you’ll want to do everything possible to ensure that your potential hires are trustworthy, obedient, and committed to safety and security. You will also want to consider employee health and wellness, especially if you’re working in an injury-prone industry like construction. Worker’s comp will help prevent incurring lawsuits but it’s best to keep the number of claims filed as low as possible since more claims equal increased premiums. Keeping up to date on health and safety standards can help prevent mistakes.
One of the risks of small business ownership is that, often, small business employees can be very close; some boast even feeling like a family. However, you’ll want to be careful to avoid behavior and comments that can be interpreted as harassment or discrimination. This could lead to lawsuits as well which is one reason to purchase EPLI. Most small businesses do not have their own HR department so do your best to have clear policies in this area and provide employee training as necessary. Allegations of harassment could inhibit the growth of your business for a long time after. Consider high employee turnover rate as a warning sign of risk. The Small Business Association (SBA) suggests asking yourself if this is happening because of poor hiring, poor training, unfavorable working conditions, or other possible reasons under your control.
Risks of small business ownership: when is debt rewarding and when is it trouble?
Risks of debt
Many small businesses will find themselves in need of financing as they attempt to scale, modernize, and otherwise improve their business. Calculated debt is an opportunity for many small businesses to increase their revenue because of new equipment or property, pay back their debt, and ultimately come out in the black. However, this can cause trouble for small businesses when unanticipated slumps in sales or other surprises occur. This can lead to missed payments, the inability to reinvest in your expansion, the possible seizure of collateral, and eventually defaulting on the loan. Debt can ruin small businesses. The Small Business Association (SBA) gives this advice to assess warning signs for bad debt: calculate your debt-to-equity ratio (S/E). Add together your short-term and long-term obligations to assess total liabilities. Then, divide this total by the owner’s equity which can be found on the company balance sheet. The rule of thumb is if the debt-to-equity ratio is above 40% to 50%, you should reassess your financial strategy. This means that you are paying for up to 50% of your company through debt. See tips for managing debt here.
Benefits of debt
As much as debt has the potential to damage a business, it also carries the potential for a huge payoff if done right. By taking out a loan or opening a line of credit instead of selling equity, you can keep more control of your business in the long run. You can also finance equipment you may need to complete a contract as long as you’ve done the math and find that the ROI exceeds costs, including after-tax interest for your loan. Being financially responsible can make financing a pivotal part of your growth and overall success. If you’re having trouble identifying the risks to your business, do a SWOT analysis: strengths, weaknesses, opportunities, and threats. Some risks of small business ownership, like debt, may turn out to be opportunities when you look at the whole picture.
