Asset Protection for Business Owners: some basic ideas
The most frequent questions I receive from business owners relate to asset protection. Common sense and a little extra care can do wonders to provide significant protections for the business owner and the business.
I was recently contacted by a business owner regarding these things–namely, asset protection for himself and his business. He wanted to know if I had any suggestions for how he should operate his business and how he might improve his asset protection profile. I had never met this person (he was referred to me by his accountant) and he didn’t give me much information, other than the following: he had an LLC, but it was delinquent, soon to be expired; he paid his home loan, and his car payment with his company checking account and he had no insurance. He let me know that from his perspective, things were probably ok and that he really just wanted me to affirm that he was doing everything right.
It was clear to me that this person had no interest in retaining me to do much (if anything) for him and for his company. Rather, he was assuming I would quickly respond to his e-mail with a “looks good” and he could then be on his way (having checked off “asset protection review” from his to-do list). I responded to him via e-mail that his first step should be to renew and update his LLC and get an operating agreement for the same. He should then make a significant change in how he managed his business and personal accounting matters. In other words, he should stop paying his mortgage and car payments with his business checking account and should generally do everything possible to institute a bright line of separation between his personal assets and his business assets. I explained that the protections of his LLC (i.e. the legal liability firewall benefits of the same) were in many respects directly proportional to the degree in which he operated his business separately from his personal life/assets. Conversely, if he co-mingled those things and failed to have a meaningful separation between his personal and business assets/accounting, he could be putting his personal assets at risk if there was any type of business creditor or other legal liability claim. Finally, I told him that he most definitely should get insurance protection, both through general corporate insurance and also through both business and personal umbrella insurance policies.
I responded to this person in the order of his questions to me. In other words, I started with his LLC because that was the first thing he asked me. In retrospect, I probably should have first and foremost strongly suggested that he obtain business liability and umbrella insurance policies as soon as possible. I’m not an insurance agent, so there is nothing for me to gain in making such recommendations (and, frankly, there was nothing for me to gain at all in that transaction because he was not and did not become a client). However, I have learned over the years that the best first line of protection in almost all settings, including in the business world, is having proper insurance protection.
We can do a great deal to institute legal protections of all kinds, and I am a firm believer in such things (since that is where I earn my livelihood), but such legal protections should normally not be the front line defense. Rather, insurance coverage should be the first thing that is thought of and used when it comes to protecting against liability. The very nature of the modern insurance industry provides that a business and/or a person can obtain a high dollar level of insurance coverage for a comparatively low cost. The insurance industry utilizes actuaries to predict and manage risks and then to spread the costs associated with such risks among a large body of insurance purchasers. Since only a small percentage of such insurance policies will have claims, the proportional cost of high dollar risk insurance is quite low. Further, as long as you purchase your insurance from a highly-rated company, you need not be concerned about the validity of your insurance coverage. In other words, if you have a claim for $250,000 and such a claim is covered by your insurance policy, that $250,000 will be paid by the insurance company. So again, having an adequate amount and proper scope of business liability insurance should be the first item on your list of asset and liability protection as a business owner.
Using a limited liability company should come as a close second on that list of simple, but very important, asset protection strategies. There are actually many benefits of using an LLC, and asset protection is certainly at the top of the list. That is, assuming that the LLC is properly established and maintained over time. But when all goes according to plan, the name of the legal entity is a “limited liability company” for a reason. The LLC is designed to serve as a legal liability firewall in most instances. This means that claims made or otherwise arising in the context of the business operations should be kept within the LLC and its assets (hence the use of the analogy to a firewall).
Along with using an LLC for the ownership of business assets and the operation of company activities, business owners will want to have a customized operating agreement for the LLC. The operating agreement is the “rule book” for the legal entity. It sets forth how profits and losses are allocated, transferability of equity, buy-sell provisions, and many other important items. In addition to the importance of having such key terms and conditions clearly agreed and memorialized for the benefit of business owners, I believe that there is an added measure of asset protection that comes from having the customized operating agreement. Among other things, this gives a clear indication that the LLC is being treated as a “real business.” While that may seem too easy and to simple to be true–you would be surprised just how much truth one can find in simplicity…:) A general rule (simple though it may be) is that when business owners operate their company (small, medium or large) as a real business, with all that entails, they should be able to have a high degree of confidence that statutory and common law protections will be theirs in the event there are legal liability claims. At the very core of such legal protections should be respect for the separation of business and personal assets and liabilities and this should result in corporate claims being kept within the scope of the company and its assets.
Ok, that is probably more than enough on this topic for today. Next time, we will continue the discussion about asset protection by reviewing with such things as separate bank accounts, separate accounting generally and related matters which normally fall squarely within the real of accountants. A little bit of a hint here is that having a good accountant who is proactive and careful is another very important step to take in successful business operations in general and when it comes to asset protection in particular. So if you don’t currently work with a good accountant–one who is proactive and responsive, you should find one who fits that description. If you need help, let us know.