How To Protect My Business Equity

An asset protection planning strategy that can limit liability risks, is the use of holding and operating companies. The ideal business structure has an operating entity that owns no vulnerable assets while the holding entity owns the assets of the business. Within this structure, small business owners could eliminate or significantly limit the liability of both the personal and business debts. 

In terms of asset protection planning and limiting liability in your business structure to avoid losing your personal assets if your business runs into financial difficulties, the limited liability company (LLC) and corporation emerge as the two best choices of all the types of organizational forms available to small business owners. For most small company owners, the LLC will be preferable to the corporation, however inheritance planning and tax implications must be carefully addressed.

Even if the company is organized as an LLC or corporation, the owner of the company faces an asset protection problem. Although running your business as an LLC or a corporation shields your personal assets from business creditors, your business assets remain exposed. The company may still lose all it has, which could mean disaster for a small business owner.

Safeguarding the owner’s assets from personal creditors and protecting the owner’s assets from business creditors appear to be opposing goals. Assets held in the business form are exposed to the firm’s creditors, but are insulated from the owner’s personal creditors to some extent. Assets held outside of the company form, on the other hand, are exposed to the owner’s personal creditors while being safe from the firm’s creditors. 

So, how can you safeguard all of your assets from corporate and personal creditors? Both objectives can be met at the same time if the firm is properly funded and structured.

Two entities make up the optimal business structure:

(1) An operational entity that has possession of assets but does not own them (unless they are encumbered in favor of the holding entity or owner), and

(2) a holding entity that owns the assets. 

True, this multi-entity strategy needs forethought and professional counsel. You’ll also need to balance the funding of various companies using both equity and debt, such as leases, loans, and liens, once you’ve adopted the multiple-entity method.

The assets of an operational corporation can be protected to some extent by employing only one entity and leases, loans, and liens, as well as by using a separate holding company. This is an illustration of multi-layered security.  

The simplest alternative, a one-entity strategy, does not, in most cases, provide the flexibility and asset protection that a multiple-entity model does. It all boils down to how willing you are to jeopardize all you’ve worked for in order to save a little time and effort.

Using Multiple Business Entities

Using holding and operational businesses to minimize liability in your business structure is an asset protection planning technique. As previously stated, the ideal business structure consists of a holding corporation that owns the business’s assets and an operational entity that does not possess any susceptible assets. The small business owner can use this structure to avoid (or at the very least considerably restrict) responsibility for both business and personal obligations.

The operational entity is responsible for all of the company’s operations and, as a result, carries all of the risk of loss. Because the operational entity has few or no susceptible assets, and the holding company is not legally accountable for the debts of the other firm, the owner’s limited responsibility for business debts turns out to be no liability at all. At the same time, because assets are protected by a corporate structure, the owner’s liability for personal obligations is decreased (i.e., the holding entity).

Advantage of Using an LLC 

This strategy works better with two limited liability companies (LLCs) than with two corporations, as long as the holding LLC is formed in a state that has adopted the Revised Uniform Limited Partnership Act, which prevents foreclosure and liquidation of the business interest to satisfy a personal creditor. 

Because the legislation permits personal creditors to attach and vote on the owner’s stake, forcing the company to liquidate, two corporations will not be able to safeguard commercial assets from personal creditors. The statutory close company, on the other hand, offers another alternative. You may accomplish the same safeguards by forming it as the operational business and combining it with an LLC as the holding entity.

What Are Your Options for Creating Entities

The holding entity can be created and funded by the individual owner. The operational entity can then be formed and funded by the holding corporation. The holding entity owns the operational entity, and the holding entity owns the individual. This is a common corporate strategy in which the operational business is a subsidiary of the owning entity. The LLC, on the other hand, can be approached in the same way. 

Alternatively, the owner may form and fund both organizations himself, giving him direct ownership of both. Alternatively, the owner might choose to operate as a single company, however this form offers very little protection for your business and personal assets.

Tip for Not Having to Own Multiple LLCs

13 states have passed laws governing Series LLCs. These statutes offer a one-of-a-kind chance to incorporate all of the distinct companies into a single LLC. 

In most cases, it is preferable for the holding corporation to own the operational entity. The various entities are then carefully supported in order to reduce the number of susceptible assets in the company structure.

Effective Use of the Holding Entity

The holding entity is when all money is located inside the business structure in the multiple-entity method. However, because the holding company does not engage in any commercial operations, it is nearly completely immune to liability, and so these assets are safe. 

The holding entity is established by the small business owner or owners. The holding entity then establishes and owns the operational entity, which is where actual company activities (and risks) take place. The operating company’s limited liability extends to the holding company and is restricted to its investment in the operating company, with the exception of the holding company’s owners, who do not own the operating business. Although a single holding corporation might operate several operating businesses, it is important to maintain each operating company and its operations separate from one another.

When financing the companies, a firm’s most valuable assets should ideally be owned by the holding company and leased to the operating company, which protects the assets from creditors and allows the running company to take vulnerable cash out. 

Furthermore, the holding company can lend money to the operating company to acquire additional business assets, but the collateral for the mortgage should be secured by liens that flow to the holding company. The assets are secured once again since the holding company is a priority lien holder, and the running firm’s susceptible cash is taken out through loan repayment.

The multiple-entity strategy is successful when correctly designed because it attempts to increase wealth inside the business while minimizing assets while the entity bears all risks. Because the holding company, not its shareholders, forms and funds the operating company, the holding company is accountable for the operating company’s obligations, but only up to the amount it has invested, provided the holding company is structured as a limited liability corporation (LLC).

Effective Use of the Operating Entity

Your operational entity is your principal business entity when employing holding and operating businesses in a multiple-entity business structure. Within such firm, all business functions take place. Similarly, all of the business’s risks will manifest themselves within that entity. 

Continuous withdrawal techniques are crucial from an asset protection viewpoint since they decrease susceptible assets and cash within the business. These should be in place and functioning as part of routine company operations.

Separate operational entities should also be created for each operating activity, so that any responsibility is limited to the assets of that business. A “series LLC” is particularly well suited to the use of multiple entities.

Using Series LLCs in a Multiple Entity Structure

If you’re thinking about combining holding and operating businesses in a multi-entity corporate structure, the Delaware limited liability company (LLC) legislation offers unparalleled flexibility and simplicity. It expressly permits the formation of “series LLCs,” which allow for the formation of several classes of interests, including voting and nonvoting interests. 

Because of the popularity of the Delaware bill, numerous other states have enacted similar legislation.

The Following are States Permitting Series LLCs:

• Delaware
• Illinois
• Iowa
• Kansas
• Minnesota*
• Nevada
• North Dakota*
• Ohio
• Oklahoma
• Tennessee
• Texas
• Utah
• Wisconsin (allowed, but no liability shield between the interests)

Generally, these rules enable a single LLC to host many distinct companies. As a result, a single LLC can serve as both the holding entity and the operational business. 

Each unit can have its own set of owners as well as different types of ownership interests. Each unit has the ability to own and incur its own assets and obligations. Each unit should have its own accounting system, which might be as simple as individual files within a larger accounting system. Importantly, each entity’s recordkeeping must be done as if it were a distinct LLC.

The articles of formation must designate the units, or “series” of independent companies inside the single LLC, as they are referred to under the legislation. This identification serves as a tacit acknowledgement that each unit is an independent legal entity, and that the other units are not responsible for its obligations. Because the registration is a link to the original articles that were filed in one of the Series LLC Statute states noted above, when the single LLC registers to do business in the owner’s home state or wherever it will conduct operations, this registration will also serve as constructive notice in those states.

Although Series LLCs are commonly used in real estate and may be utilized in other sectors, do not attempt to form this type of multiple entity without seeking experienced legal advice first. Series LLC are very new creatures, and there is no precedent to guide our care and feeding of them. No one knows how the IRS will handle the nuances and difficulties that may develop as a result of this new form.

It is critical that the registration be completed correctly in order to segregate liability amongst the businesses. Each unit does not required to be financed immediately, which is consistent with the usually flexible nature of most Series LLC regulations. They can be put on hold for later use.

Warning to Professionals

Professionals can only create a limited liability company (LLC), a limited liability partnership (LLP), or a corporation if all of the owners are licensed in the same profession. 

If you’re a professional (physician, dentist, or attorney) creating a holding and operating business, keep this in mind. 

This is a criterion that only the operational entity must satisfy. The holding corporation, which will keep virtually all of the company’s wealth, will not engage in any professional activities. Thus, even though the holding company is created by professionals, children or other family members might still be co-owners. This enables a family LLC to be used as an estate planning tool. However, because the holding entity cannot be the owner of the operational entity, the professional would have to create each entity separately in this situation.

In this case, if the entities were established under a single Delaware LLC, the holding entity would have to be constituted as a distinct LLC. Within the single LLC, each operating unit might still be created. 

Obviously, forming two or more organizations rather than one incurs additional expenditures. However, the notion of a sub-entity, as contained in Series LLC legislation, can considerably reduce these expenditures. Furthermore, these expenses, which are actually rather low, serve as a form of low-cost insurance against the danger of loss.

Securitization Requires Multiple Entities

Large firms also employ strategies that rely on the usage of an operational company and a holding entity. “Securitization,” for example, is a rapidly expanding sector of corporate finance. 

A corporation, the operating company, sells its receivables to a second business, the holding company, which is formed. The holding company’s sole actual asset is the receivables it buys. The holding company sells shares to the general public, thereby letting the general public to own an interest in the receivables by purchasing stock. Securitization is the phrase for this. This tendency began with banks selling mortgages, an ironic use of words in today’s economic climate. Accounts receivables are now sold in this manner by large businesses.

The holding company (the master LLC) is protected from accountability for all of the acts of the operational firm that generated the receivables. According to commentators, securitization would not function without the formation of a holding corporation because the risk of liability exposure from the operational entity’s operations would be too great to allow this type of public stock offering. (Whether they were commentators or false prophets will be determined by history.)

At the same time, the operational corporation has safeguarded its assets from creditors’ claims. Cash received from the sale of receivables is swiftly depleted to cover operational expenditures, including the wages of the operating entity’s owners. A variant of this method may be used by a small business owner to withdraw assets from the operational corporation, but only after great consideration and preparation.