Like any other investment, starting a small business brings a certain level of risk. While those who have good ideas for small business start-ups should not be discouraged from pursuing their plan, it is wise to investigate and have a thorough understanding of the various risks that will be assumed and the steps that can be taken to minimize those risks.
It is always advisable to consult with a lawyer and other business professionals to better assess the risk of your particular venture before getting started. Some of the most common risks associated with starting a small business include:
• Financial risk caused by unprofitable operations that lead to the inability to pay creditors.
• Malpractice in connection with the provision of professional services or product liability if the business is a manufacturer.
• Contractual risk resulting from the inability to perform per the terms of a contract.
• General liability such as someone being injured in your place of business.
The extent to which personal assets could be lost from small business activities will vary depending upon whether you elect to operate as a proprietorship or to incorporate the business. As a proprietor, you are doing business individually, which leaves personal assets, such as home equity and vacation homes, more exposed. In most cases, if the business is incorporated, only business assets will be available to judgment creditors.
However, lenders will generally require loans to small corporations to be personally guaranteed by the owner(s). Under this scenario, creditors with personal guarantees will look toward personal assets for collection if the corporation cannot repay its debt. Obviously, if your home or other assets, were pledged to secure business loans, the lender would proceed directly against the collateral in the event of default.
Liability insurance will only provide partial protection against loss of personal assets. While it may be available for general liability, such as accidental injury, it will not cover common risk. Although malpractice coverage and product liability insurance does exist, many small businesses may find that it is either too costly or unavailable in their field.
One of the safest ways to protect your personal assets when starting a small business venture is to “bootstrap” the business or, simply put, do not borrow money initially. Use only your time and saved money to get started. Once the business is under way and a defined cash flow has been established, money to fund growth can be more safely borrowed.
A second method of protection, which should be used in all cases, is the development of a sound business plan. Among other things, the plan will include financial projections which will serve as a road map for the new business. The plan should show at what point funds will be required, when break-even is reached and when loans can be repaid. The plan should also include contingency provisions and reserves.
While risks involved in starting a small business will never be totally removed, proper planning can go a long way in reducing the chance of failure.