How Can Businesses Protect Themselves From Surprise Costs?
According to the U.S. Census Bureau, there were more than 400,000 new business applications each month during 2021. According to the Small Business Administration (SBA), however, half of these are likely to fail within five years.
Businesses fail for any number of reasons, but unexpected costs can create acute difficulties. These extra expenses can eat into profits, destroy budget plans, and frustrate investors. You can't anticipate every possibility, but we identify costs that might otherwise surprise you below.
Some surprise costs can arise out of your business structure. Three common business structures are the sole proprietorship, the partnership, and the limited liability company (LLC). Be aware that each structure has different legal and tax requirements.
- A sole proprietorship is an unincorporated business operated by a single individual. If you start a new business and do not choose a specific structure, it will automatically be a sole proprietorship by default. One drawback to this structure, which could catch you by surprise, is that you can be held personally liable for the losses and debts of the business. If your company runs into financial or legal troubles, your personal assets could be at risk.
- A partnership is a formal agreement between two or more people to operate a business. Each partner contributes resources, skills, or finances to the business and gets a corresponding share of the profits. As is the case with sole proprietorships, partners are personally responsible for the debts of the partnership. The personal assets of partners can be at risk if the business can't pay its debts.
- A limited liability companies (LLC) is a business entity that provides certain legal protections to the owners, known as members, while allowing them to run the company as a small business. An LLC is a separate and distinct legal entity. While the company is liable for business-related debts, fines, and litigation, the individual owners are not personally responsible. You need to file documents in your state and pay annual fees to ensure that your LLC meets all requirements and remains active.
For all business structures, you can reduce your exposure to surprise costs if you make sure you have the proper business licenses for your city and state and adequate insurance coverage (more on that below).
New businesses may run into legal problems. The best strategy is to try to identify potential problems beforehand so that you can either avoid them or have a plan in place to deal with them should they arise.
Legal compliance can present a significant challenge, especially for new business owners who may be unfamiliar with the legal landscape. Legal requirements vary by industry and typically include, among other things: sales tax collection, financial reporting, workplace safety practices, employee benefits, overtime rules, and permits and licensing.
If your business overlooks any requirements, authorities could levy fines. If you operate on a tight budget (like most small businesses do), a single penalty can be a major financial setback.
You can take steps to avoid these issues by working with a lawyer or accountant to ensure you understand all general regulations and those specific to your industry. Getting professional help is worth the expense. You can also mitigate legal risk by obtaining business liability insurance in case the unexpected occurs.
Businesses spend an average of $1.2 million fighting litigation each year. Business owners are often surprised by the legal issues they encounter. For example, if you violate occupational health and safety protocols or breach tax or employment laws, it could lead to a lawsuit. Similarly, you could get sued if a product you make or sell injures someone.
Lawsuits are expensive. Even settling a legal issue out-of-court may require you to have to, at the minimum, hire a lawyer.
You can reduce the impact of litigation costs if you structure your business as an LLC and have adequate liability insurance.
Other Business Costs Might Surprise You
When forming your business, you can plan for certain expenses. Make sure you give enough thought to the ones we discuss below.
Business insurance is a necessity for most businesses. Depending on your industry and operations, you may need general liability, product liability, professional liability, and commercial property insurance. In some cases, a general business owner's policy will be sufficient. If you have employees, you need worker's compensation insurance.
One way to reduce insurance costs is to avoid overlapping coverage. Overlapping coverage occurs when two or more policies cover the same risk. You need to check your policies and communicate with your insurer if you have questions about the scope of your coverage so that you can avoid redundancies.
Businesses that sell goods are common targets for thieves. You can be robbed of those goods. You can be robbed of the equipment you need to run your business. You can also be the victim of an employee who uses their position to engage in fraud, embezzlement, or other less-common financial crimes.
Pay close attention to your general business insurance policy. Some policies do not cover theft by employees or other crimes that do not involve a break-in. You may need a separate business crime insurance policy to cover losses of this nature.
You can sustain property damage in any number of ways. It could be the result of natural causes (fires, tornadoes, hurricanes, floods, or earthquakes) or from human causes (riots, vandalism). Either can bring your business to a standstill.
Replacing damaged property can be costly. Once again, good insurance is the answer. It's worth the expense. Make sure to check the scope of your coverage to make sure you are getting what you need. Some property and business insurance policies may not cover certain natural disasters such as floods, so you may need to expand your coverage.
You should also have a plan in place for restoring business operations if you sustain catastrophic property damage. This will reduce the amount of revenue you lose.
Replacing employees who leave your business can be expensive in terms of both time and money. You need to find, hire, and train new employees. You need to provide them with insurance and benefits. The Society for Human Resources Management estimates that it costs $1,500 to replace an hourly employee.
You cannot reduce the impact of turnover costs through insurance. You have to plan for it. Do your best to attract quality job applicants and take the time to vet them. Hire those who seem the most qualified and committed.
All businesses have to pay taxes. The tax rules that apply to you will depend on your business structure and the nature of your business. For example, sole proprietors have to pay self-employment tax. If you run a retail business, you will need to account for sales tax.
Hiring a tax professional is worth the expense. They can advise you about strategies like monthly or quarterly prepayments, which can help you avoid a massive once-a-year tax bill. They can also ensure that you properly deduct business expenses, comply with reporting and withholding requirements, and avoid getting stuck with tax penalties and bills.