As a business owner, do you devote alot of time and energy “working in” your business to improve business operations and profitability, but neglect to “work on” your business by not addressing certain asset protection issues?
Business owners, particularly those owning their business in corporate form, should consider the following:
- How to own C corporation or S corporation stock to minimize exposure to creditors, an outside asset protection issue.
- Whether to implement several basic business agreements designed to protect and even enhance business value from the inside of the corporation.
A business owner who owns S corporation or C corporation stock should consider the asset protection benefits of converting or merging the corporation to a new Limited Liability Company. There are several limited liability organizations that can protect business assets from the personal liabilities of the owner. Limited partnerships, or limited liability limited partnerships, are treated as partnerships for federal tax purposes and therefore cannot own S corporation stock, but an LLC electing to be taxed as a corporation can.
The asset protection benefit of an LLC is a judicial remedy, called a charging order, that protects the owner’s interest in the LLC from their personal liabilities. If a creditor obtains a charging order, the creditor is limited to the rights of an assignee of a membership interest in the LLC. If a distribution is made from the LLC, what the creditor receives will be proportionate. The creditor doesn’t have any voting rights though, so they can’t force a distribution, liquidate the LLC, or otherwise manage the business.
Among the basic business agreements or legal documents that should be considered by business owners to protect business value include a Non-Compete and Confidentiality Agreement, Buy-Sell Agreement, and perhaps even a Deferred Compensation or Bonus Plan for key employees.
Few events can sap the value of a small business like a key employee or associate leaving the business and starting a similar enterprise, especially if the employee departs with trade secrets, confidential information or even customer lists. As a business owner, you should require your employees to sign Non-Compete and Confidentiality Agreements to prevent this from occurring. If the terms of such an agreement are considered reasonable, the agreement should be enforceable.
A Buy-Sell Agreement is another key document that if properly structured, funded, and updated will protect the value of both the existing and remaining business owner’s interest in the business. The Buy-Sell Agreement accompanied with proper planning will provide the existing owner a fair value for their ownership interest and provide the remaining owner a means to purchase the existing owner’s interest without depleting the business of cash flow and its value.
A Buy-Sell Agreement is designed to establish a predetermined and agreed-upon business value, at the occurrence of events such as the death, disability, voluntary or involuntary termination, or retirement of a shareholder or partner.
Planning needs to be done to ensure there are sufficient funds available to implement the buy-sell provisions when triggered. Funding at an owner’s death with life insurance may be the easy part. More problematic may be how to buy-out a departing owner’s interest in the event of disability, retirement or voluntary termination, especially if a portion of the business’ cash flow must be devoted to that purpose. Further, once in place a Buy-Sell Agreement should periodically be updated to reflect changes in the business value and the owners’ objectives.
Finally, business owners should consider putting into place a deferred compensation or bonus plan designed to reward key employees who meet certain performance targets. A properly planned deferred compensation or bonus arrangement can serve two purposes which will work toward protecting the value of the business. The plan should be designed so that employees are rewarded for achieving benchmarks that not only protect but increase the business value.