The Importance of Asset Protection: Acting Before Catastrophe Strikes

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The Importance of Asset Protection: Acting Before Catastrophe Strikes

Operating your business to harvest profits isn’t enough. You may be totally unaware of the internal and external threats that you face. Creditors may file lawsuits for the recovery of dues. Customers can claim compensation for injuries, disabilities, and financial losses, holding you responsible. Consumer protection advocates can initiate class action for defects in products and services, and claims can run into millions of dollars. If you don’t protect yourself adequately, you stand to lose your business, your reputation, and your personal assets. It is only by understanding the risks that your business faces, and devising strategies to protect assets, that you stand a chance of running your venture successfully.

Why Is Asset Protection so Important to Businesses?

Creating an asset protection strategy is like building a firewall. You never know the nature of a threat, where it comes from, and the damage it can do. By building a firewall of legal protection, lawsuits and claims can be neutralized, leaving your business assets intact. A strong legal framework protects you against adverse judgments that sully your reputation and seize your assets. Asset protection reduces risk and secures the company against creditors and emerging threats.

Understand the Nature of Risks That Threaten Businesses

Before you create an asset protection plan, it’s best if you come to grips with the kind of threats that businesses routinely face.

Most internal threats come from employees that sustain some kind of injury or become disabled or die in harness. These situations can be tackled using the assets of the business, insurance, healthcare, and HR compensation plans, and won’t threaten you personally.

The most dangerous threats are external. Creditors can come after your assets to recover dues. If assets are weak, you could be sued for personal liability. If a pedestrian is injured in your construction site, he can sue you for personal injury and compensation. But if your commercial vehicle negligently causes grievous injury or death, the claim may go beyond compensation to fix a personal liability on you.

You need protection plans that tackle different assets differently

Shares, bonds, and bank accounts are considered safer assets that do not generate personal liability to the extent of dangerous assets. A well-oiled management structure oversees asset handling, and specific people can be held responsible for financial losses or service deficiencies.

Commercial properties, rented apartments, tools, and industrial equipment, and commercial vehicles are more dangerous assets. Claims from these sources seriously drain wealth and fix personal liability on you. Creating a separate ownership charter for such assets is an effective way of limiting personal liability.

Let’s assume you’re a practicing physician, and both the building and the practice are in your name. If your practice attracts a lawsuit, the claim can easily escalate to engulf your property too. You stand to lose both the practice and the real estate. The solution is to insulate yourself from the operational side of the business to limit personal liability.

A Rundown of the Most Popular Asset Protection Strategies

We spoke of creating a legal framework that cocoons your business in a protective shield. Corporations, LLCs, and trusts provide the legal firewall that shields assets and owners from damaging claims.

Business Corporations

Corporations are legal entities where shareholders are owners who elect directors to a board which decides who runs the day-to-day business. Broadly, there are three types; the C Corporation, the S Corporation, and the LLC. They all have one thing in common; the owner’s personal assets are safe. Creditors and other parties satisfy claims from business assets, not the assets of the owners.

The personal liability protection is not a blanket guarantee; there are exceptions. For example, you’re a cardiologist working as a paid employee of a hospital that you own. You are delivering a personal service, and any deficiency could expose you to a personal liability claim.

You need to draw a line that separates the corporation from you and gives it a separate identity. Otherwise, an attorney could invoke a strategy called “piercing the veil” to make you personally liable for losses and deficiencies.

C Corporations (C-corps) and S Corporations (S-corps)

The difference in these models lies in the way the business is taxed. In an S-corp, the business isn’t taxed and profits flow to the shareholders and get reflected in the shareholder’s income tax return. In a C-corp the business is taxed separately at the corporate level. The owner is liable to report only the dividend and salary income he receives. The benefit of corporatization is that you’ll have a system in place that takes care of business by shielding you from personal liability

Limited Liability Corporations – LLCs

Single-owner proprietors or partnerships of two or more investors would prefer the flexibility of an informal management structure. The rigidity of large corporate structures may not look appealing. Such individuals may prefer the LLC. The flexibility extends to the tax reporting system. The single biggest takeaway of an LLC is that owners enjoy limited liability in case of business losses or claims regarding deficiencies in service.

The Drawbacks of A General Partnership

This is a loose bonding together of two or more individuals committed to a business arrangement that could be inked on paper or be oral. This is the most dangerous option from the asset protection angle because one partner can be held responsible for the mess that other creates. If you sink, you sink together.

One way out is to become a limited partner within a general partnership. This automatically limits one’s liability, but the negative is that one loses influence over the way the business is run by the general partner. Overall, a partnership is not a secure vehicle for asset protection. You can lose everything merely by associating with a partner acting against your best advice.

Setting up a Trust in One’s Lifetime

A trust is a three-cornered agreement; there’s the trustor or grantor that creates the trust, and appoints a trustee to oversee the trust operations. The trustee manages the trust for the benefit of a third person – the beneficiary. You could either build a living trust (in your lifetime) or make it part of your will (testamentary trust).

Revocable or changeable trusts are more prone to liability suits as you are perceived to be in total control of your assets. The safer route, the strategy best suited for asset protection, is the irrevocable trust; one that you can’t change. Safety lies in the fact that you can’t be pulled up for an asset that can’t be modified or controlled by you.

Matching the Asset Protection Strategy to Your Needs

Being aware of risks is fine; understanding the type of risks that assets attract is good; the vehicles that can protect your assets are now known to you. This begs the question, how do you customize an asset protection strategy to your unique set of requirements?

If you are rendering a service as an accountant, a software engineer, a banker, a doctor or as a lawyer, your risk profile for personal liability is higher. The LLC route would suit you because of management and tax flexibility. You can rest assured that ownership and your personal assets are safely insulated from the company’s assets and liabilities.

To play safe, it’s better if you place some layers between yourself and the company management and not be directly involved in company operations as a paid employee.

If you wish to retain and move wealth within the family, go for a Family Limited Partnership (FLP) in which family members pool their resources to run the business. There are income tax and estate tax benefits to be gained. A business succession plan would be easier to formulate taking seniority and experience into consideration.

Instead of one single vehicle, a combination of various asset protection vehicles could make it difficult for creditors to attach assets and damage finances.

The advantage of opting for an LLC or Corporation is that the business tackles its liabilities, keeping you out of the loop. You create problems only when you personally guarantee a debt or some liability.

The Bottom-Line: Prioritize Asset Protection to Ensure Your Business Swims and Doesn’t Sink

Mere profits will not sustain you if your business is wide open for predators to wreak havoc. A well thought out, meticulously crafted Asset Protection Plan is as important to your business as the time, energy, skill, and resources that you invest to make your enterprise profitable. Make a beginning by understanding the risks you’re prone to; next, study the strategies that’ll protect your business, then match the strategy to nullify the risk. Within no time, you’d have built an iron dome that deflects incoming missiles aimed by your worst enemies.

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