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Formal business entities provide additional liability coverage
So, clearly, in order to fully protect your business and personal assets, you need more than insurance. You need to take steps to place assets beyond the reach of your creditors. One of the most important steps to take is to conduct your business in a manner that separates business assets from your personal assets.
You have a variety of options when it comes to structuring your business: sole proprietorship, partnership, C corporation, S corporation and limited liability company (LLC).
Choosing the structure
The best way to protect your personal assets from the reach of business creditors is to operate your business as an LLC or as a corporation.
While both can be effective to shield your personal assets from business creditors, the LLC has some advantages in terms of simplicity and flexibility. Of course, the best structure for your business turns on many complex and personal factors, so your best bet is to use this information as a starting point for a conversation with a business advisor, such as an attorney or accountant.
Avoid undoing your careful planning.
While forming as an LLC or a corporation generally protects your personal assets from business creditors, it’s easy to trip up and cost yourself this protection. How? A common mistake is to personally guarantee a business debt or obligation. A creditor can go after any co-signer. As a result, your personal bank account could be tapped to pay a business debt. You must keep a wall between your business and personal life, if you want business creditors to do so.
Actively managing finances to preserve your wealth
Once you have a structure in place that protects your personal assets from your business creditors, you’ve made significant progress, but you may want to consider an additional layer of protection for your business. Why? Because, it is the owners who enjoy limited liability from business creditors: the business can lose everything it owns. In order to protect as much of your wealth as possible, it’s best to have as little invested and maintained in the business as possible. You can manage this by strategic funding and structuring and by careful planning of day-to-day operations.
Holding companies and operating companies.
One of the tried and true ways to thwart creditors is to structure your business using two entities: a holding entity and an operating entity. As the names imply, the “holding entity” holds the title to the business assets, leasing or loaning them to the “operating company,” which conducts the day-to-day business. Yes, all this does sound complicated. However, if you have a highly successful business or a business that has significant exposure to lawsuits, such as a restaurant or construction company, the initial aggravation and cost will reward you with substantial peace of mind over the long run.
No one of these asset protection strategies is enough to protect you and your business, should something go wrong. But combined together, these strategies can offer almost impenetrable protection to the business owner who legally operates a business—and who makes these preparations in advance.
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