Consider Separate Entities for Your Business

All of the assets relating to your business operation do not necessarily have to be in the same company.  There may be perfectly valid business reasons to have real estate, equipment and/or other assets in separate entities.  The following chart provides an example of a possible business structure.

Many assets in the above structure are not part of the operating company.  So a judgment against the operating company may have no impact on the other assets. 

Each situation of course has to be examined on its own.  Asset transfers can have tax consequences.  But there can be valid business reasons for using multiple entities - - and this may provide significant protection for many of the assets utilized in your business.  

$8.5 Million Jury Verdict Reflects Cost of Lifelong Care

An $8.5 million jury verdict seems high, doesn’t it?  But if you consider that the injured party was an infant who suffered brain damage (and will require lifelong care), then the amount of damages could be perfectly reasonable. 

According to a recent article by Tom Feran in the Cleveland Plain Dealer, a Cuyahoga County Common Pleas jury has ordered MetroHealth Medical Center in Cleveland to pay $8.5 million to the mother of a child who suffered permanent brain injury at birth several years ago.  While the hospital contended that a placental infection caused the problem, the jury found the hospital to be negligent.  I have no idea if imposing liability on the hospital in this particular case is justified or not.  But I do know that medical and other expenses for an injured party can cost many millions of dollars.  If you are found to be negligent in providing professional services, or in a business activity, or say in an auto accident, you could become responsible for an enormous amount of damages.

While I firmly believe that all individuals and businesses should carry adequate insurance, it is also reasonable to take advantage of laws that allow you to protect your assets.  It is always possible that you could face a judgment in excess of insurance limits – or for something that is not covered by insurance.

 

Most Small Business Owners Have No Succession Plan

In several prior posts on March 19, 2010, February 23, 2010, November 6, 2009 and July 2, 2009, I emphasized that a business succession plan is critical for most closely held businesses. Yet according to an article last week by Marcia Pledger in the Cleveland Plain Dealer, fewer than 30 percent of small business owners have any kind of succession plan. That is according to Bob Nemeth of the consulting firm of Apple Growth Partners in Independence, Ohio.

There are all kinds of reasons that small business owners never get around to focusing on business succession. One of the principal reasons is that they are simply so busy with day to day business operations; and there is frequently inadequate time for long term planning.

Over the years I have helped many clients with business succession planning, and I have found that there are numerous benefits that clients do not even expect. In addition to getting a solid plan in place, the succession planning process often helps focus the business owner on a variety of other matters that may not have received adequate attention including:

  • key person life insurance
  • personal estate planning
  • updating corporate records
  • strategic planning for the business
  • a variety of other matters that simply have not been focused on in many years

Perhaps most important of all, getting some sort of business succession plan in place can bring great peace of mind to the business owner. This is one of those “priceless” benefits of the planning process.

This post is just another reminder that the time and effort involved in business succession planning can pay huge dividends for a closely held business owner.

Volatile Economic Conditions

The Dow Jones industrial average fell 324 points last Friday, its second worst slide of the year.  The drop pushed the stock market back into a "correction" -- meaning a decline of at least 10% from its recent high.

While I remain optimistic about the economic future of our country, we obviously face great challenges in the coming years.  Stock market volatility is here to stay.  General economic conditions remain uncertain; and competition from abroad will be a constant challenge.  So it remains critical to examine your assets from time to time (business and personal) and consider how well they are protected from creditors.

If you are a resident of Florida and own a home in Florida, and most of your assets are in IRA's and qualified plans, you have little to be worried about from an asset protection standpoint.  On the other hand, if you live in Northeast Ohio and a significant portion of your assets are invested in a family business, it is vitally important that you consider how well your assets are protected from creditors.

Many people focus on asset protection after some economic disaster strikes them.  By that time it is often too late.  The time to focus on protecting your assets is now -- before you have any creditor problems.

More Advice on Business Succession Planning

In a post last month, I emphasized that a business can be lost or severely damaged by lack of a meaningful succession plan.  The title of an article in yesterday's New York Times says it all -- "Lack of Succession Plan Puts Family Venture at Risk".  The article has some useful suggestions for closely held business owners, and it outlines some of the items that should be addressed in a succession plan.

In a February post I noted that business succession planning should be a team effort.  Some matters require business expertise; but many issues require sophisticated legal planning.  For example, the New York Times article mentioned some fifth generation family owners in Columbus, Ohio who prepared a fifteen year plan to pass on the company to the next generation, using a mix of grantor retained annuity trusts and family limited partnerships.  These vehicles can lower tax liabilities as well as provide a legal framework for succession in the business.  This is a good reminder that careful business succession planning may help save taxes and provide other benefits in addition to simply determining who will run the company.

Business Succession Planning

A business succession plan is a key component of any asset protection plan.  In most cases, a family business constitutes a large percentage of the owners' assets.  Yet a significant number of businesses have absolutely no succession plan in place.

In thirty years of representing family businesses, I have come to understand why succession planning is so difficult.  There are many reasons for this but I believe three of the most significant are as follows:

  1. It is simply difficult for many business owners to imagine that anyone else (including family members) will run their business as well as they do.  And they are frequently correct about this!  Unfortunately, this is not a good reason for having no succession plan in place.  It reminds me of naming guardians for minor children in a Will.  Most parents feel that no one would raise their children with the same care and attention that they would; and that is probably correct.  It is nevertheless foolish to simply ignore what would happen if both parents died.  The same is true in business.  Lack of a succession plan can lead to confusion and needless controversy following the death, disabilty or retirement of the owner.
  2. Many business owners have thought of succession planning, but simply do not know where to start.  All that is really required to get started is to contact a professional...either an attorney or business consultant who specializes in this kind of planning.  Business succession planning should be a team effort involving a number of professionals.  But someone needs to spearhead the effort, and this is frequently the job of an attorney or consultant.
  3. Finally, I find that in today's lightning-paced business environment, it is simply hard for business owners to find the time for succession planning.  Business owners should realize that developing a succession plan can save huge amounts of time and money in the future.  Speaking in business terms, there is generally a huge return on investment.  This alone should be an incentive to do some planning.

Business owners today are rightfully concerned about catastrophic lawsuits and other creditor problems.  I would guess, however, that more businesses are lost or severely damaged by the lack of a meaningful succession plan than by an unexpected, catastrophic lawsuit.  Asset protection in today's business environment is abouletly critical.  And a business succession plan is a key component of asset protection.

Why Businesses Need to Focus on Asset Protection

My law offices are in the Eaton Center Building in downtown Cleveland, Ohio.  So a recent headline in The Cleveland Plain Dealer Business Section -- stating that Eaton might owe billions in damages in an antitrust case -- naturally caught my eye.  A jury in federal court in Wilmington, Delaware found that Eaton Corp has monopolized the market for commercial truck transmissions.  The company now faces paying billions of dollars in damages to a competitor.

Eaton does not owe anything immediately.  There will be a second trial to determine the amount of damages; and there will very likely be appeals.  But the case illustrates how one single court judgment can have a catastrophic effect on even a very large company.

While the Eaton case involved an antitrust claim, a catastrophic judgment can result from even a simple contract case.  For example, in the 1980s a Texas jury found Texaco liable to Pennzoil for tortiously interfering with a contract between Getty Oil and Pennzoil.  The jury verdict was for $7.52 billion; and the jury added another $3 billion in punitive damages.  Texaco Inc. v. Pennzoil Co. (1987), 729 S.W. 2d 768 (Tex. Ct. App.).  Texaco of course appealed (all the way to the United States Supreme Court), but the ultimate resolution of the case involved Texaco paying $3 billion and filing bankruptcy.  Texaco at the time was one of the largest corporations in the United States.  This is another classic reminder that a single jury verdict can have an enormous impact on a company -- even a very large company.

My post of July 2, 2009 titled "Asset Protection for Your Business" outlines some of the simple strategies that an organization can use to protect at least some of its assets.  Unfortunately, many small business owners tend to focus on asset protection only after some huge lawsuit is filed or some court judgment is entered, at which time it is generally too late to do anything.

Asset Protection Strategies for Your Business

There are a number of relatively simple strategies an organization can use to provide significant protection for its assets.

1.                        Separate Entities. Consider creating a separate entity (possibly a limited liability company) to hold real estate, machinery, or assets relating to a new line of business. If there were a future judgment against the corporation, the assets held in the separate entity or entities would likely not be subject to that judgment as long as appropriate formalities were followed. Tax issues can arise in connection with the transfer of assets, and these should be considered prior to any transfers. For example, the transfer of real estate out of a C corporation into a limited liability company could trigger a significant amount of tax, and thus make the transfer impractical. But if additional real estate or a significant piece of machinery or equipment is being acquired, having a new limited liability company purchase it (and then lease it to the corporation) could have significant advantages. 

2.                        Limited Liability Companies. A limited liability company (“LLC”) is a hybrid type of legal entity that has some characteristics of a corporation and some characteristics of a partnership. 

  • Owners of an LLC are called members;
  • They can elect to receive pass through tax treatment like a partnership or an S corporation, or to have the LLC taxed like a C corporation;
  • They have limited liability like in a corporation; 
  • They have a great deal of flexibility in management structure. 

LLCs can provide significant asset protection advantages. A creditor of an owner of a corporation (that is, a creditor of a stockholder) often can gain control of a corporation by getting control of the owner’s stock. Creditors will have a much more difficult time gaining control of an LLC. Thus, many business owners now prefer to form an LLC instead of a corporation when the need for an additional entity arises.

3.                        Insurance. Review all of your business insurance with both your attorney and your insurance agent. Since your attorney is not selling any insurance products, he or she can often provide an objective review of the types and amount of your business insurance. Having adequate insurance is one of the most important (and generally one of the most cost effective) ways to provide protection for your business.

4.                        Update Corporate Records and Follow Required Formalities. Many closely held businesses do not keep their corporate record books up to date. In the event of a lawsuit against the company, a plaintiff’s attorney can attempt to “pierce to corporate veil”. This means the corporation will essentially be ignored and the owners (shareholders) will be personally liable for the corporate debts.  Following basic corporate formalities, including

  • Holding an annual shareholders meeting;
  • Holding regular meetings of the Board of Directors;
  • Avoiding any mixing of personal and corporate assets; and
  • Keeping corporate records up to date.

will all help to insure that the assets of the owner(s) of the business are insulated from any judgment against the business. One of the many advantages of an LLC over a corporation is that LLCs require fewer formalities in both their organization and operation. However, piercing of the LLC veil is also possible under various circumstances, including inadequate capitalization or failure to maintain a separate indentity (for example, failing to have a separate bank account for the LLC). 

5.                        Business Succession Plan. Many business owners lose sleep worrying about lawsuits and other potential legal claims. While these concerns are often justified, more businesses collapse from lack of a business succession plan than from a lawsuit bought by a party unrelated to the business. Lack of such a plan can lead to fights among family members, including litigation, which can be disastrous at both a business and a personal level. Paying attention in advance to at least some form of succession plan can save an enormous amount of trouble later. Life insurance should be considered as one part of the business succession arrangement. Good business succession planning is also a form of asset protection planning. 

6.                        General Legal Review of Business Operations. Is your business in compliance with applicable employment laws and other regulatory requirements? Has your employee manual been reviewed recently? One lawsuit will likely cost far more than a basic legal compliance review. A legal “check up” is like a medical check up: identifying one or more serious problems and taking care of them now can avoid a much greater problem later.