I see lots of people start up their side hustle, but very few protect themselves from their side hustle. Why is it that you can get your friend the handyman to do something for $50 that the licensed insured handyman charges $150 for? Why does it cost $1000 to paint a room with a contractor, but $200 to have the local kids do it? Well, there are a few reasons, the first is experience level. When you hire a professional you expect the following things: The job to be completed on time, in a workmanlike manner. You expect the professional to be insured (in case something is broken/damaged or there is a problem). And, you would expect that they will return your call if you call them again.
To protect your business (let’s assume your side hustle is beyond friends/family), you should have a few things set up
- Your DBA or LLC/Corp
- An operating agreement or partnership agreement for the company
- A bank account dedicated to your business
- At a bare minimum liability insurance for your business
- Auto insurance that covers you for business purpose (if you use your vehicle for the business)
- Worker’s compensation insurance if you have any employees/helpers (they should be getting paid via w2 in most cases, not 1099, but speak to your tax professional for clarification on this. I am not a CPA)
Having these docs/protections in place costs $, but protect you from huge risks if you don’t have them.
Why do I need an LLC or Corporation? (EIN)
Having an LLC (Limited Liability Company) or Corporation (Inc.) essentially separates you from the business. While there are many tax reasons to do so (in the future I will talk about c-corps, s-corps and pass through taxation), the biggest reason to have an entity for your business in protection. If the company gets sued (and you do not have a personal guarantee), and you lose the case, it could force the LLC into bankruptcy. If that happens, you are not personally liable (there are exceptions to this rule- known as piercing the corporate veil, but they are very uncommon). This protection is critical to you (and your business) to ensure that you are not intertwined. Also when you go to sell the business, it makes an asset purchase/sale much easier, and helps you as mentioned above with tax and accounting.
Why do I need an operating or Partnership Agreement? In most cases, even if you are single member LLC or corporation, the bank will require an operating agreement to open up a business banking account. If they do not require it, it’s still a good idea to get one drafted (there are many free simple operating agreements online which are good for single member entities, as there are no potential disputes with yourself over legal issues). When there are partners involved having a partnership/operating agreement is even more critical. Whether the partners are active or silent, a partnership agreement is a legal document (that should be prepared by a lawyer on behalf of the company, and I would recommend having a lawyer that is independent of the company review it for your interests, not just the partnerships). This document outlines who is responsible for what in the company. It also outlines how buyouts, and buy ins happen. How people are compensated, and when, as well as what happens if more money is needed to be injected into the company. It should also outline what happens if someone is unable to work due to disability or death. I have seen many of these things come to pass, and after not having a strong operating agreement, and losing over a million dollars in one of my ventures, I now take this precaution incredibly seriously. There will be another blog post in the near future reviewing partnership/operating agreements!
Why do I need a dedicated bank account for the business?
Having a bank account just for your business prevents a few things.
- It makes sure that for tax purposes the money isn’t commingled so you can clearly define what is and is not taxable income. It is important not to pay personal expenses from your business account and business expenses from your personal account, as it could lead to a messy audit in the future. This also allows you to pay certain business related expenses with your business funds, taking advantage of pre-tax dollars. Some things like cell phone bills, internet for your home office, and auto related bills (if you use the vehicle for your business) could be qualified business expenses that can be paid pre tax via the business. You should talk to your accountant about this.
- Having the separate bank account makes it easier to create Profit and Loss statements, and file business tax returns, which will be necessary if you want to A) Borrow money to grow/expand your business, or B) Sell your business. When selling or borrowing money its important to be able to show a clear picture of how the business is doing.
Why do I need liability insurance?
Liability insurance protects you and your business from the unexpected. Just like you have health insurance to protect you in case you get sick or injured, and car insurance to protect you from accidents both physically and damage to your vehicle and property, business liability insurance protects you from harm that comes to yourself, your business property, your employees, and customers. Having business insurance is good, but its extremely important to know what kind of coverage you have. Is it only liability? Do you have employee dishonestly coverage? Do you have an inland marine policy? Do you have cyber security? Do you have umbrella over your auto? These are all questions your broker should be able to help you answer once they learn about what it is you do in your business, and assess what protection you might need.
Why do I need Business Coverage for my auto insurance? If you or your employee use your personal vehicle for business purpose, and get into an accident, the business could be held liable for potential damage both financially and legally that arise. Having umbrella insurance over your business liability policy and auto liability policy are a big help, and usually to do so you will need some type addendum, or notation that you have coverage for business purposes on your auto policy. I am not a licensed insurance agent, so please reach out to your trusted insurance broker for advice on this, or if you don’t have one, I’ll be glad to introduce one to you!
Why Do I Need workers compensation?
So legally in New Jersey, if you are a solo operator and have no employees you don’t need worker’s compensation if you waive it. If you have employees you can still waive for yourself, but it is mandated to carry for your staff. Each state is different so you should talk to your licensed insurance agent to review what coverages/limits are needed. In New Jersey the premiums are standardized, with rebates available for good loss history.
As a reminder/disclaimer I am not an accountant, lawyer or insurance agent. I am not qualified to give legal counsel, everything described above is from my experiences owning/managing/buying/selling businesses. Having these protections and pieces in place, help you make a recognizable puzzle! I’m happy to introduce you to professionals in any of these environments, and I do not receive commissions from any of these people. They are simply people I have worked with and trust, whom I want to see grow their businesses/practices. As you can see all of these extra pieces do cost money, but having them is critical to your long term success! I never want to feel in retrospect that I was penny wise and dollar foolish.