By Maurie Cashman
Protecting assets is critical when engaging in Ownership Transition Planning. Ownership Transition Planning assumes that the better the business, the easier and more successful the Ownership Transition. Ownership Transition Planning also assumes that good businesses are not only profitable and well managed, but that they are protected from liability risks. Protecting your business value from legal liabilities is a fundamental Ownership Transition Planning practice.
Last week we discussed the need to continuously innovate to keep your business relevant and valuable. This week we will discuss the need to continuously look for ways to protest those assets you have so carefully built over the years.
You would have thought Kevin Wilson would be thrilled, but he was worried. He’d just watched his biggest competitor go out of business after unsuccessfully fighting an employment discrimination lawsuit. He scheduled a meeting with us about protecting his assets. Kevin wanted to know how to protect the business’s assets in addition to his personal assets. Like most owners, Kevin’s business comprised the majority of his net worth. He would lose almost everything if he lost the business. We confirmed Kevin’s worst suspicions, “You’re a smart businessman, but you expose your company’s entire net worth to every risk.”
Kevin responded a bit defensively, “What do you mean? Iâ€™m careful in running my business. Yes, I have business risk, but my business is a corporation. Doesn’t that give me liability protection?”
We explained that indeed, operating as a corporation provides a layer of personal protection but 75 percent of Kevin’s wealth was concentrated in his business. “If creditors take the business assets, you’re left with very little. Let’s work to protect both your personal and your business assets.”
Kevin is hardly the exception: many, if not most, business owners expose their assets to annihilation by a successful lawsuit. In Kevin’s case, the bulk of the company’s equity, represented by an inventory of $5 million could be insulated from the operational liabilities.
Here’s what Kevin did to achieve that insulation.
First, he separated the operation of the business from its assets. He severed that part of the business likeliest to create liability exposure (operations) from the bulk of the business’s net worth (the inventory, cash, trade secrets, etc.). To accomplish this, he retained the existing corporate shell and formed a new, Limited Liability Company (LLC). He transferred the operations of the company into the new LLC. As its name implies, an LLC generally limits liability for acts of the LLC to the assets of the LLC. The bulk of Kevin’s business assets (remaining in the original corporation) are thus protected. They aren’t part of the LLC, therefore they cannot be attacked for any actions of the LLC.
Second, he removed his personal guarantees from every lease, promissory note, and financing agreement. While Kevin’s guarantee had been vital during his start up years, he was able to negotiate its removal with his lenders.
Third, Kevin’s insurance advisor initiated a full review of Kevin’s casualty and liability coverage including a discussion of captive insurance companies.The formation of a captive insurance company is a lengthy process including feasibility studies, financial projections, determining domicile, and, finally, preparing and submitting the application for an insurance license. The need for a qualified insurance manager on the planning team is very important, particularly in the formative stages.
Check with your tax and legal advisors to see if this particular strategy is appropriate for your situation. There may be significant tax implications involved that should be examined. Please remember: you are not alone! If you find this information valuable, please pass it along to your friends. The highest compliment we can receive is for you to forward our blog or to comment on it!