Can your company's creditors touch your home or your car? Not if you plan well in advance.
Can your company's creditors touch your home or your car? Not if you plan well in advance.
When the economy gets rocky, smart company owners separate their business and personal resources
At first glance, a swimming pool might seem completely irrelevant to managing a fast-growing company. But for Bob Bickert, CEO of Crown Products, in Mobile, Ala., a manufacturer of promotional products and #140 on last year's Inc. 500 list, there is a strong connection.
"Until recently, we operated only within a strong economy," Bickert says. "We had done so well that I had decided to install a swimming pool at home for my family. But as the economy has turned tougher, I changed my mind about that -- along with making a number of other business and personal financial decisions that should strengthen our ability to withstand whatever problems may occur."
In anticipation of customers' tighter budgets, for example, Bickert has added a low-priced product line to Crown Products' mix. He's also made significant cutbacks in his personal compensation -- mainly by scaling back on bonuses -- to keep more cash in the company's coffers.
For lack of a better term, call what Bickert is doing "downside planning." In its ideal form, business owners find ways to protect their personal assets while preparing for the worst for their business. In the current challenging economic environment, a company's worst-case scenarios might include the bankruptcy of its biggest and once-best customer, a banker's decision to close down its corporate credit line, the postponement or cancellation of an impending initial public offering, or the meltdown of a company's value.
As Bickert's actions show, downside protection can take many forms. But whatever your own company's specific needs, there are two issues that every business owner should focus on: asset diversification and protection from creditors.
According to Roy Ballentine, a certified financial planner with Ballentine, Finn & Co. in Wolfeboro, N.H., asset diversification makes sense in every type of economic climate. He says: "When I'm dealing with a business owner, I always try to point out to him or her that concentration of assets is a very risky proposition. That means you're always in a financially precarious position when most or all of your assets are tied up in a single entity, whether that's your own company or anyone else's."
Ballentine urges his entrepreneurial clients to accumulate personal assets outside their companies as soon as corporate cash flow can support decent owners' compensation. "What you want to do is keep these funds in a well-diversified group of fairly liquid investments. That way, if your company loses value or even goes under, you'll still have sheltered a portion of your household's assets," Ballentine says.
Unfortunately, it's much harder for owners to diversify their personal assets during lean business times than when the stock market is surging, along with the company's cash flow. So if you find yourself forced to cut back on your compensation -- or even to cash in some of your family's outside investments to raise capital for your venture -- you'll need to delay diversification until conditions stabilize.
Concentrate your energies instead on protecting your personal assets from business creditors. Creditors can range from a bank lender to somebody who wins a judgment against you in a lawsuit. (Lawsuits, by the way, are likely to increase in tough economic times.) Sanford J. Schlesinger, cochair of the family-owned-business practice of law firm Kaye Scholer LLP in New York City, urges owners to think about what he terms "asset segregation" to avoid potentially catastrophic personal exposure. "You want to make certain that personal assets are kept separate from business assets," he advises.
As a first step (one that you've probably already taken), incorporate your company to protect yourself from personal liability for business debts. Then follow these simple rules: Don't use your personal credit card for business purchases unless you file an expense report, and go through proper channels to get reimbursed. It's safest never to use a corporate card for personal transactions. Keep separate bank accounts for your company and your family.
"What you want to avoid is anything that might 'pierce the corporate veil," says Sandra E. Mayerson, leader of the national bankruptcy practice of law firm Holland & Knight LLP, who is based in New York City. "That is the term that lawyers use to describe a situation in which an owner has poked so many holes in his or her legal safeguards -- by failing to follow the rules that govern corporations -- that a judge decides it's fair to poke some even bigger holes."
A common mistake: one spouse owns the home, the other owns the business; then both spouses sign personal guarantees that support a business loan.
Although it's sometimes tempting to ignore formal procedures, Mayerson urges business owners to "stick to the basics. Make sure you have an annual meeting, even if it's only by telephone, and keep board minutes that document whatever issues were discussed. When unusual transfers of funds take place in either direction between you and your company, keep records that explain the transaction -- whether it's a bonus that was voted upon by the board or a loan, in which case you'll want to document its terms."
Depending on how cautious you want to get in your downside planning, you might decide to shift the ownership of certain personal assets away from you. The simplest way to do that is to transfer the ownership of your family's home and other holdings to your spouse (assuming that he or she is not involved with the business and your marriage is secure). But if you go that route, warns Ballentine, make certain that you "don't execute any documents that unwittingly expose your spouse to the company's obligations through some type of 'backdoor' rule, which would eventually allow creditors to get their hands on these assets." An example of a common mistake: one spouse owns the home, the other owns the business; then both spouses sign personal guarantees that support a business loan. "The only way you can make matters worse," says Ballentine, "is by keeping the business loan and your home mortgage at the same bank, which might impose a 'cross-default' mechanism on you -- so that both loans automatically go into default if you run into problems with either one of them."
If your situation is really dire and your business is filing for bankruptcy, you might take advantage of a protection-from-creditors loophole offered by the state in which you own your home. "Thanks to what's known as the 'homestead' law, families can shelter some or all of the value of their homes from creditors. But the amount of the homestead exemption differs significantly by state," notes John Hutchins, a partner at the Boston office of the law firm Kirkpatrick & Lockhart LLP. There's a proposal afoot in Washington to set a national limit of $125,000 on the homestead exemption in bankruptcy. Another loophole worth investigating: many states protect life-insurance policies and annuities from creditors.
Some advisers take the extreme position that the only strategy for business owners is to set up an offshore trust. "We do this very often for high-net-worth individuals," reports Daniel Mielnicki, the national coordinator of the wealth-preservation practice of law firm Greenberg Traurig LLP. "It is never the intention to hide assets from creditors. In fact, your creditors should know about these trusts. But the goal is to make it as difficult as possible for anyone to get at the assets that are contained within these trusts." His recommendation: "Don't try to put everything you have into one of these trusts -- just what you would need to live comfortably if, in a worst-case scenario, you lost everything else. And certainly don't attempt to put assets into them if you're in the midst of a lawsuit or any other situation in which your activities could be viewed as an attempt to defraud an existing creditor." Offshore trusts are definitely a high-end strategy: for people whose net worth is less than $10 million, the cost and complexity of the maneuver usually outweigh the benefits.
Other advisers, including Mayerson, distance themselves from the offshore strategy. "Clients come in to see me with the most complicated schemes, which often involve offshore trusts," she says. "What I tell them is, 9 times out of 10, if you've moved assets into some kind of trust at a place like the Cayman Islands and something goes wrong with your business, you will be tarred and feathered by the idea that you've behaved improperly, whether or not you really have. I'm convinced that people are far better off protecting themselves by setting up a solid estate plan and then taking advantage of whatever state loopholes exist. And they've got to remember, the further away [in time] they do this from any problems arising within their businesses, the better off they are."
Here's one final tip, wherever you find yourself on the spectrum of downside planning: involve your corporate attorney and accountant. In the long run, you'll find it's much cheaper than going it alone and then later discovering holes in your financial parachute or "corporate veil."
Jill Andresky Fraser is Inc. 's finance editor.
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