Real world issues make the best blogs. We often hear clients mention insurance as a means of protection. In this article we explain the role insurance plays in protecting you and your business as it relates to personal liability.
Personal liability is a very big deal and should generally be avoided. It means that you are personally responsible. Personal liability means your personal assets are at risk.
An example of personal liability: Imagine getting a loan from a bank for your business and then defaulting. If you are personally liable for that loan, then the bank could take your personal assets, including your house, car, and college savings. This is because personal liability exposes your personal assets to satisfy a wronged party. Thus, the goal is to limit or avoid personal liability so as to protect your personal assets.
Takeaway: Avoid personal liability.
Mitigating risk, meaning to reduce personal liability, is the absolute goal. The idea is to limit as much personal exposure as possible.
You may ask, why mitigate (limit) personal liability? Why not avoid entirely? Great question! It shows your thinking is on the right track!
Personal liability often arises as a matter of practical necessity due to industry standards. An industry standard is common within a given industry, and therefore difficult to avoid. For example, most banks will require a personal guarantee for small business loans (thus making you personally responsible to repay your business loan). Practically, you may not have a choice. If you want a loan for your business, then you may have to personally guarantee that business loan.
Franchise agreements are another common source of personal liability. Replete with personal liability[1], franchise agreements generally require personal guarantees (the provision making you personally liable for your franchise/business). The same logic as with the lender example, if you want to own a franchise you probably must give the franchisor a personal guarantee or they won’t let you buy a franchise.
Takeaway: Avoid personal liability; mitigate exposure.
Avoid the heart attack. To further explain personal liability and insurance, let’s play Would You Rather!
Would you rather:
Not have a heart attack
(Prevention = Limiting Liability)
Or
Have a heart attack?
(Fixing Damage = Insurance)
I use this analogy all the time because it is powerfully simple. Obviously avoiding a heart attack altogether is preferable. Trying to fix the damage after a heart attack means the damage has already been done. That’s insurance, a fix.
But what if you could prevent the bad?
Prevent personal liability with a corporate shield. LLCs are, by their very nature, designed to limit liability. A limited-liability company (or an “LLC”) is designed to protect your personal assets by limiting liability! Within the analogy of a heart attack, LLCs are designed to stop heart attacks from happening, by shielding your personal assets from liability. That’s powerful!
Insurance does not prevent liability. It reimburses. In addition to the robust protections afforded by your LLC[2], insurance serves as a piece of your overall protection. LLCs are designed to prevent liability from ever reaching you personally. Insurance does not prevent liability, as instead it is designed to kick in when you experience a loss.
To relate back to the lender and franchise agreement examples: personal liability only extends to the other respective party. Using the business loan example, your personal liability only extends to the lender. Thus, LLCs remain overwhelmingly beneficial because they protect your personal assets from the rest of the third-party universe! That’s a lot of protection from a lot of people!
In conclusion, why have a heart attack when you could stop it from ever happening. Be proactive! Avoid the bad with an LLC!
Key takeaway: LLCs provide a shield from personal liability. Insurance reimburses, as its compliment.
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Craig Morgan is a business, franchise and contracts attorney and a partner at the law firm Morgan & Forb, PLLC. Licensed in North Carolina and Ohio, we serve intellectual property and franchise clients nationwide. To speak with one of our attorneys, please call (704) 287-9093 or click here. We offer the initial call at no cost to you.
[1] Franchise agreements are potentially negotiable.
[2] An LLC is a type of corporate entity, like a corporation. LLCs are generally my recommended entity type for the majority of our clients because they are easy to work with and offer considerable protection from liability.
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