When you own a business, it’s important to ensure your assets are protected. Being sued or carrying large amounts of debt could pose a threat to both your business and to your own personal finances. Fortunately, there are steps you can take to safeguard your assets against these kinds of dangers. Creating an asset protection plan that covers both your business and your personal assets can be an essential part of your overall financial planning strategy.
Understanding the Dangers of Debt
Debt by itself isn’t necessarily a bad thing; it’s how you manage debt that becomes important.
Say you run a construction business, for instance, and you take out a large loan to help fund a new expansion project. As part of the loan agreement, you offer some of your business assets as collateral. You also sign a personal guarantee for the loan.
The business is doing well and cash flow is strong, so you don’t foresee any issues. But a couple of years into your loan repayment, a recession hits and your business revenues drop because building projects dry up. Suddenly it’s not as easy to manage your loan payments as it was before. You end up defaulting on the payments.
At this point, the lender has a couple of options. They can seize the collateral you pledged to secure the loan to satisfy the debt. Assuming the collateral’s value is equal to the remaining loan balance, that might be the worst of it. But if not, the lender has an additional recourse thanks to the personal guarantee you signed.
What Does a Personal Guarantee Do?
A personal guarantee is a legally binding agreement that makes you personally responsible for debts owed by your business, potentially including a commercial lease. A lendor might require a personal guarantee as a condition for the loan, and it might also help to get you better terms on your loan.
The downside is that if you default and there’s insufficient collateral to offset what’s owed, the lender can attach your personal assets to recover the debt. For instance, they could sue you personally and garnish your bank account or place a lien against your house.
It’s important to understand the potential consequences of taking out a business loan, or any other loan that requires collateral or a personal guarantee, before signing on the dotted line.
“If you actually default it’s too late to make moves to protect yourself, like transferring assets, setting up trusts and corporate shields and moving assets into them,” says Ike Devji, an asset protection attorney and founder of ProAssetProtection.com. “That’s overtly punishable as fraud, both civilly and criminally.”
Devji says the kinds of assets that could be at risk include bank accounts, business equipment, receivables due to the business, real estate the business owns, intellectual property and any other personal assets in your name. When both your business and personal assets are pursued by a lender for a defaulted loan, filing for bankruptcy protection may be your last resort option.
Bankruptcy can keep your creditors at bay and potentially eliminate certain debts altogether, depending on which chapter you file. But, your business and personal credit scores could suffer. And in the case of a Chapter 7 filing, you may still be required to liquidate certain assets so those funds can be passed on to your creditors.
Lawsuits Can Be Equally Problematic
While your business may be staying on top of its debts, a lawsuit can take you by surprise.
There are any number of reasons why your business could be sued. For instance, a former employee may file a lawsuit claiming that you unfairly withheld wages or accusing you of discrimination. A customer could sue you claiming that they were injured by one of your products. Or one of your vendors could slip and get hurt while delivering supplies to your business premises, triggering a personal injury lawsuit.
Most often, it’s the business that’s being sued. But in some instance, it’s possible that you could be sued personally for damages. This can put both business and personal assets at risk, particularly if you’ve commingled your funds, says Tina Willis, a personal injury attorney and founder of Tina Willis Law in Orlando, Florida.
Judgments can wreak havoc with your credit scores and they can linger on your credit reports for up to seven years. A judgment can be the precursor to a creditor taking further action against you, such as attaching your personal or business assets.
Business Structures and Insurance
You want to grow your business while preserving the assets you’ve worked so hard to accumulate. The first step is choosing the right business structure.
“All businesses should have some sort of legal business entity formation, like a corporation or limited liability company,” Willis says. These types of legal structures can offer more protection for your personal assets compared to operating as a sole proprietorship. As its name would indicate, a limited liability company (LLC) is explicitly intended to limit the owner’s personal liabilities (in addition to some tax benefits).
The next step is getting the right insurance coverage in place.
That includes having a high limit personal umbrella policy to cover your home and vehicles, as well as a high limit policy for general liability insurance. You may also want to consider having specialty insurance for the business to cover less common occurrences, such as data breaches, employee lawsuits and workplace injuries or deaths that occur as the result of a criminal act. The amount of coverage depends largely on the what the business is valued at, what you want to protect and the combined value of those business and personal assets. Both Willis and Devji agree that a seven-figure umbrella policy is a good starting point.
Something else to consider is what tools won’t work in protecting your assets. You may be relying on a revocable living trust, for instance, to shelter your assets against lawsuits or debt collection efforts during your lifetime. But protection isn’t necessarily guaranteed. You could, however, use a living trust to protect your beneficiaries from any future liabilities stemming from lawsuits or bankruptcies after you pass away.
Use Caution When Taking on Loans
If you’re going into debt for your business or personally, there a few things you can do beforehand to protect yourself. Specifically:
Avoid personal guarantees whenever possible.
If you have to sign a guarantee, negotiate a cap on the percentage of your personal assets a lender could attempt to collect against if you default.
Offer specific collateral in lieu of a guarantee whenever possible.
Double-check your business’s legal structure to determine whether you or the business is liable for the debt.
And consider carefully whether the business can afford to take on debt for the short- or long-term. Review cash flow statements for the previous year and run some cash flow projections to make sure debt repayment would be sustainable. If taking on new debt would put the squeeze on revenues, it may not be the right time for a loan.
The Bottom Line: Be Proactive
The time to protect your business is well before a lawsuit or unpaid debt becomes a problem.
“You can’t act after the fact,” Devji says. “If you have assets that you don’t want to or can’t afford to lose, protect them now. It’s always cheaper and more predictable than acting late.”
And make sure you’re building in layers of protection to your business and personal financial plan. Having the right business structure, the appropriate type and amount of insurance coverage and an attorney to guide you are all key pieces of the asset protection puzzle.
Tips for Managing Business and Personal Assets
While a financial advisor is a good idea for anyone looking to manage their assets and grow wealth, it’s especially important for business owners. Many advisors specialize in working with business owners, and can help with asset protection, succession planning and more. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
Retirement planning works a little differently if you own or work for a small business with no 401(k) plan. Check out our guide to small business retirement plans, and use our retirement calculator to see if your current savings have you on pace for a secure retirement.
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