“Can he sue me?!!” Clients often ask that question after a business transaction goes bad or when a business partner objects to an important decision. My answer is always the same: Any knucklehead with $200 (the cost of court filing fees) can sue you.
Anyone who starts a business is exposing himself or herself to legal and financial risks. Some of the risks are very simple and obvious, like when signing a lease, hiring employees, opening a credit account with suppliers, and the like. Some risks are not so obvious. For example, what if your products or services are defective or cause harm to some third party, or what if your business partner/investor goes through a divorce? Unfortunately, there are new risks being created every day, everything from environmental problems to sexual harassment. The question that is asked over and over again is, “How can I protect myself and my assets?”
There are enough issues, questions and answers on this subject to fill a book. I will address a few of the most important points and provide a very brief overview. I invite readers to submit any specific, hypothetical questions for later columns.
You may have seen an ad recently that promised “A Nevada corporation can give you 100% asset protection! Call 1-800-555-5555.” The phone number I’ve shown is make believe, but the ad was real. Sadly, there is no such thing as 100% asset protection. However, putting a business in a limited liability company or corporation can isolate a great number of risks related to the business. Because it is so easy to create a limited liability company in Oregon, every small business owner should do so. The fee for filing Articles of Organization is $100. The Oregon Corporation Division has a website that is very helpful.
Forming an LLC is just the first step. The owner (referred to as a “member”) must establish a separate bank account and otherwise be careful to conduct business in the name of the LLC, rather than in your individual name. If more than one member is involved, it is important to have an Operating Agreement which spells out your relationship and your rights. In particular, the agreement should address what happens if one member wants to leave.
In addition to forming an LLC, business owners should find an insurance agent they trust to help them select the appropriate insurance for the business. As your business grows, the types of insurance you need will change, but initially insurance should not be very expensive. Individuals should always inquire about an umbrella policy to provide personal protection above and beyond any auto and homeowner’s insurance. Again, the right insurance agent will make these decisions easy.
Another very basic rule for asset protection is to avoid signing personal guarantees. Most new business owners will be required to guarantee significant contracts such as leases and credit agreements with major suppliers. Under no circumstances should your spouse sign a personal guaranty. Having some assets owned by your spouse is a good way to make sure that you don’t have “all your eggs in one basket.” In the case of real estate, when a husband and wife own property together, it is referred to as a “tenancy by the entirety” and is entitled to certain special safeguards, so long as only one spouse is liable for a debt.
It seems so obvious, but people often forget that an IRA, 401(k), or other pension plan offer the best asset protection. I tell clients they should never raid their retirement account to cover business debts. Think of your retirement account as a lifeboat. If your business is an ocean liner, you would not chop up the lifeboats to stuff into the boilers just to keep the ship going for a few more miles. Qualified pension funds are protected up to an unlimited amount.There are also statutory exemptions against collection for certain key household and homestead assets which provide a safety net against personal financial catastrophes. Although we hate to think about what could happen if the business fails, that possibility should be part of your initial asset protection planning.
The very best advice is to assess your risks and take steps to protect your assets before there are any signs of financial problems. When the sun is shining and the sky is clear, you have a better chance of protecting yourself and your family than if you wait until the storm clouds are on the horizon. Many types of asset transfers and transactions can be challenged by your creditors if they occur after financial problems arise.
If the asset protection planning is done at the outset, you will have greater flexibility. Under some circumstances, you may even be able to establish irrevocable trusts to benefit your family and assist with any estate planning goals that you may have. Those are subjects for another day, but well worth your time and energy.
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