Small business owners are no strangers to risk management. Owning and operating a small business entails a certain level of unpredictability. Despite your best efforts to stay on top of supply chains, marketing, sales, competitors, employees, and cash flow, unexpected issues can knock you for a loop. You have survived plenty of bumps in the road and emerged stronger than ever. But are you prepared for the financial hit—not to mention the stress and emotional impact—of a lawsuit?
You should be, according to the statistics. In a given year, roughly half of small businesses face litigation or are threatened with it. For large corporations that can afford in-house legal counsel, lawsuits are a cost of doing business. But for small firms, a lawsuit could be a hit to their bottom line that is difficult or impossible to absorb.
Small Businesses Bear a Disproportionate Litigation Burden
A Small Business Administration (SBA) survey found that an estimated 36-53 percent of small businesses are involved in civil litigation each year. The cost to businesses stemming from litigation increased from $300 billion in 2016 to $343 billion in 2018, according to the Institute for Legal Reform (ILR). The ILR also found that smaller businesses have a higher liability burden than larger businesses. Those with less than $1 million in annual revenue bore 39 percent of the liability costs, as compared to businesses with more than $50 million in revenue, which bore 37 percent. Although the overall percentage is similar, on a per-dollar-of-revenue basis, the litigation cost burden is ten times higher for the smallest businesses.
Every dollar spent on litigation is a dollar that cannot be spent on hiring, growth, or new products and services. Lawsuit costs can even be high enough to threaten the solvency of a business. According to the SBA, the cost of litigation for small businesses ranges from roughly $4,000-$5,000 up to more than $200,000 (in 2021 dollars).
Why Small Businesses Get Sued
Lawsuits brought against small businesses can stem from a range of claims, including contracts, personal injuries, civil rights, and wages. Generally, these disputes fall into one of three buckets: customer disputes, employee disputes, and disputes with other businesses.
Dealing with disgruntled customers is nothing new for business owners. But a simple disagreement could turn into a legal dispute in some instances:
- Discrimination based on violations of state or federal law, such as the Americans with Disabilities Act (ADA)
- Refusal of service
- A personal injury suffered on the business's premises
While around 80 percent of small businesses have no employees, the other 20 percent employ nearly 60 million Americans—close to half of the entire workforce. Employer-employee legal disputes often involve the following types of issues:
- Violations of wage and hour laws
- Workplace harassment or a hostile workplace environment
- Violations of workplace discrimination laws
- Wrongful termination
- Workers' compensation
Small businesses rely on other businesses up and down the supply chain. This can lead to disputes over a variety of issues, including the following:
- Breaches of contract (for example, nonconforming goods, overcharging, or reneging on a distribution deal)
- Intellectual property issues, such as copyright infringement
Business Lawsuit Protections
America's reputation as a litigious society is well-deserved. The United States has the most costly legal system in the world as a percentage of its economy. ILR data shows that the small businesses that can least afford litigation costs are the ones that pay the most.
Not all litigation is frivolous. But at the end of the day, a lawsuit, whether deserved or not, could cost your small business everything. You can protect yourself and your business from the ever-present threat of legal action by taking the following steps:
- Choose the right business structure. A sole proprietorship is the simplest business structure, but it does not separate your personal assets from your business assets, which means that your home, personal bank accounts, and other nonbusiness assets could be at risk from a lawsuit. Incorporate your business as a C corporation, S corporation, or LLC to protect your personal assets.
- Insure your business. Your business probably has general liability insurance that protects you against slip-and-fall accidents and other injury claims. You may not be as well-protected against breach of contract claims or claims of discrimination, harassment, retaliation, or wrongful termination. Ensure that your insurance portfolio accurately reflects the full range of business lawsuit risks.
- Use contracts. Handshake deals and verbal agreements may be legally binding, but they may not provide solutions if a business dispute arises. Ensure that your deals with other businesses and customers are formalized in written, legally binding contracts that have been prepared—or vetted by—your lawyer.
- Educate your staff. Human resources policies are useful for directing internal conduct and customer service, but training and education are needed to enforce those policies. Ensure that everyone employed by your business understands what is and is not appropriate conduct.
- Protect your data. Businesses are required to keep records of certain employee data, and the data you collect from customers can be a marketing game changer. Crooks are also interested in this data, and if a data breach occurs, you could be sued.
- Foster open communication. It is incumbent on a business owner to create an environment of open communication for both customers and employees. People may feel that a lawsuit is the only way for their grievance to be heard. If you are perceived as someone with whom others can talk openly and honestly, you may be able to resolve concerns before they escalate to litigation.
As the owner of a small business, you cannot control everything. Most owners should anticipate at least one lawsuit over the life of their business. However, with careful planning, you might be able to beat the odds by taking steps to minimize risks. At the very least, a lawsuit mitigation plan can help your business avoid a legal threat. For help with your lawsuit risk mitigation strategy, please contact us.