I often hear people are thinking about incorporating their businesses because they think it is a safer bet when it comes to liability. I thought I would share some information with everyone (to the best of my knowledge) about this process and what shield it actually does provide to a business.
The main thing is most people seem to get incorporation and liability insurance confused. We will start with a definition of each.
Liability insurance (specifically, product liability) covers a person or entity (corporation) in the horrid event that something goes horribly wrong when a person uses their product. Allergic reactions, skin trauma, etc are covered by this.
Incorporation creates a business that is a seperate entity entirely from the individual. The finances and assets are the corporation's, not the individuals. In the event that a person wishes to stop doing the business, it is a much harder process to dissolve the corporation than a sole proprietership. The tax savings and credit availability are generally the big bonuses to incorporating.
Now where does this leave us? When a person incorporates their business they buy shares into it. Each share is worth a percentage of the business. For a small business such as soap making or cosmetic making the person normally ends up 100% Shareholder and is also titled Director, President, Treasurer and Secretary of that company. Now if the company does not have insurance and something bad happens as a result of the use of the product that company sold, litigation can happen and the company can be instructed to pay out for the damages.
What if the company does not have the assets required to cover the amount they have to pay out?
This is where people seem to think a corporation can save them. If the company does not have enough assets to pay in full then the litigation system looks at the shareholders of the company. In the event that you are 100% Shareholder and hold all the positions in question you can be deemed responsible for the turn of events. You are after all directing the company and making the decisions for it. This means you can be sued for the resulting balance. Yes, the company is gone at this point as everything has been taken from it, but you are not 100% shielded from litigation. They need to get their money somewhere!
So, why do I bring this up? Because I know how hard it is to find product liability insurance. I do have a link to a company that does provide it on my home page. Some people refuse to pay the annual preium and feel that incorporating, being a one time cost, is a better option. Please know that the two are not the same. An incorporated company still needs insurance, so it is no real savings.