Tips to Protect Your Business Assets
Running a business of any size can be a risky endeavor, especially in today's litigious environment. Unfortunately, many business owners do not have adequate asset protection strategies in place if they face litigation or collections due to financial hardships. Asset protection is strategic planning to minimize risk, protect assets from potential litigation and creditors’ claims, and aid in retaining and sustaining the value of the property and accounts of the business. Because creditors and other prying parties often try to collect against the owner of the business and any related assets, it is important for all business owners to embrace asset protection strategies.
Following is a list of tips you can take to further protect yourself, your business(es), and assets:
Tip #1: Create a Separate Business Entity. It is crucial to separate your personal assets from your business assets by establishing a separate legal entity. Business structures like the limited partnership (LP), limited liability company (LLC), and the corporation (C-Corp or S-Corp) are the "go-to" entities because they provide true limited liability, versus sole proprietorships or partnerships that don't adequately protect the personal assets of business owners.
The term "limited liability" means the business owners are not personally liable for the company’s debts or other liabilities. A properly established and maintained limited liability business structure restricts liability to assets belonging only to the business. In maintaining the entity, separation between personal assets and business assets is crucial to maintaining limited liability.
Tip #2: Obtain Ample Business and Personal Insurance. Complications and accidents are unavoidable, and in some instances, predictable when running a business. When such instances occur, having liability and property insurance helps keep the business and owners insulated from paying for any losses or costs associated with any alleged losses. Various types of insurance are available to entrepreneurs; what you should obtain depends on the type of business you conduct and your unique needs. If your business already has insurance, diligently review these insurance policies to ensure that the insurance coverage remains adequate to cover all assets and your business is protected from any new issues that may come up, such as shut downs due to government mandates. There is also the option of obtaining "key-man" insurance, a life insurance policy (purchased by the company) on the life of the top executive or other key officers whose absence would be detrimental to the company.
Tip #3: Keep Multiple Business Ventures Separate. Today, many entrepreneurs are serial business owners. In these instances, another way to protect business assets is to keep each business's assets separate. This requires setting up different legal entities for each business to avoid commingling of assets, ensuring that they incur separate liabilities and debt. Failure to legally separate assets can expose all of the businesses assets to each individual business’s creditors if litigation arises and one business is found liable. To fully protect each individual entity, it is crucial to separate these business interests as soon as possible, and to ensure that the documentation, banking, accounting, and record-keeping for each business reflect the separation.
Tip #4: Avoid Personal Guarantees. As a business owner, you may be asked to execute a personal guarantee to secure a service, loan, or a property lease. A personal guarantee makes you personally responsible for the debt of your business if the business cannot repay the debt. If you are asked to execute a personal guarantee, you may want to consider negotiating different terms, such as a higher payment to the vendor to eliminate the need for the personal guarantee or a limited term on your guaranty obligation. Avoiding personal guarantees can provide long-term benefits to business owners, especially if you eventually wish to sell the business.
Tip #5: Transfer Assets to a Trust. The best way to ensure that personal assets are separate from business assets is to use a well-crafted trust. A trust is a legal tool that allows a third party, generally the trustee, to hold assets to benefit another, the beneficiary. For business owners, the recommended type is an irrevocable trust because the business owner relinquishes ownership and control of the business assets. This is not the case with a revocable trust.
Tip #6: Use Irrevocable Trusts for Protection. Using irrevocable trusts can be a three-level shield against would-be attackers.
1. Place the LLC into a Trust. Anyone trying to get through the protection of the LLC will run into the issue that a trust owns the business, not the individual. Also, when an owner is sued and the creditor attempts to attach a charging order against the business, they will likely be unsuccessful, as the trust owns the business, not the individual. Simply put, a creditor cannot collect something that the debtor does not own. A well-written trust includes language allowing the trustee to withhold funds if a lawsuit occurs. This trust, being irrevocable, is out of the control of the debtor, so the creditor cannot force payment.
2. Place Personal Assets into an Irrevocable Trust. Again, when a creditor or successful lawsuit plaintiff attempts to collect, they cannot collect from the irrevocable trust. The assets and property in the trust will be safe and able to be used to benefit the family or other beneficiaries. A creditor cannot collect from someone who owns nothing.
3. Current Creditors. You cannot use a trust to shield assets from current creditors. There are Fraudulent Conveyance Statutes that will pull those assets back from the trust to satisfy creditors. Thus, the time for planning is now, before any claims arise.
Keep in mind, a revocable living trust does not protect business owners against personal liability for the business’s debts or if a lawsuit occurs because the business owner, who is typically also the trustee, can change the terms of the trust at any time before death and is still treated as the owner of the property held in the trust. However, a revocable living trust can protect you from creditors assets that pass to your spouse and children after your death. Entrepreneurs interested in asset protection should strongly consider setting up an irrevocable trust early in their business development. If a trust is created after litigation arises, the trust may be scrutinized by a court as a tool of liability avoidance.