Small business owners are subject to all kinds of liabilities in their businesses. Many small business owners and entrepreneurs would like to protect their personal assets from the liabilities of the business. Most people suggest using some form of limited liability entity (for example, a corporation or a limited liability company (LLC) for this purpose). However, because of the extensive overlap between the personal and business lives of many small business owners, this is usually not enough. A small business owner should consider the following list of items to protect personal assets:
1. Limited Liability Company. Operate your business as an LLC or corporation or other entity that limits personal liability.
- Observe Formalities. Be certain to observe all formalities of the entity (for example, sign documents in the name of the entity, have meetings of the Board or managers, etc.)
- Business Name. Conduct all the business in the name of the entity and avoid personal signatures, commitments and guarantees where possible
- Caps and Limits. Where you make personal signatures and guarantees, try to cap or limit your liability as to the amount and as to the time of the potential liabilities
2. Multiple Entities. Use multiple entities if you have significant assets in the business.
- Move assets. Move the assets away from the likely liabilities
- Loans and Security Interests. Use loans and security interests among the entities to maintain proper treatment
3. Move Assets to Family Members. Move personal assets away from the person involved in the business.
- Move to Uninvolved Spouse. If only one spouse is involved or subject to business liabilities, move assets like a house or savings and investment accounts to the other spouse
- Move to Children or Others. Move things to trusts or other vehicles for children or others, which can then be used for their expenses or college funds
4. Insurance. Consider insurance options that can protect you against business interruption and other calamities and umbrella policies for personal liabilities.
5. Legal Compliance. Have a good legal compliance review to make sure there are limited areas for fraud or other criminal or outrageous activity in your business – courts will almost always find ways to defeat asset protection strategies if fraud or other criminal or outrageous activity is present.
6. 401(k) Plans. 401(k) plans and pension and ERISA qualified plans are usually exempt from the reach of creditors. In Colorado, IRA accounts are also exempt from creditors.
7. Homestead Exemption. In Colorado, the first $60,000 of your homes’ value is exempt from the reach of creditors.
8. Common Sense. Try to use common sense to avoid risky business situations.
- Avoid excess debt
- Avoid business with the most difficult people
- Avoid areas with excessive liability
9. Asset Protection Trusts. Consider putting some of your personal assets in trusts.
- Revocable Trusts. Typical trusts are revocable trusts (trusts you can unwind). Almost all trusts under the laws of the United States are revocable. These trusts provide very little protection.
- Delaware and Alaska Trusts. Delaware and Alaska passed relatively new laws to make special trusts formed in those states irrevocable for the purpose of providing a vehicle for asset protection strategies. These trusts can be very good vehicles to protect assets that are, or can be, located in Delaware or Alaska (stocks, bonds, Delaware or Alaska real estate, etc.). They may not be as good for assets located outside these states. Since these trusts are relatively new, no one is sure how courts will deal with assets located in Colorado, for example. Will the courts follow Delaware/Alaska law or Colorado law?
- Non-United States Trusts. Trusts formed in certain non-US jurisdictions (in Nevis or the Cook Islands for example) have even more protection. They are irrevocable. These trusts provide for fairly flexible treatment for your assets until an “distress event” occurs (such as bankruptcy or a significant credit event of lawsuit). Then the trustee of the trust (which must be a third party) becomes much more limited in distributions from the trust.
- Limitations. Trusts are good vehicles if you have extensive assets that you will never need to get back. For more limited assets that you may need to do other things with, they are more difficult. A trust can provide for regular distributions, but they create inflexibility for your assets.