Asset Protection: How To Protect Your Assets Using Business StructuresArticle written by John
A real estate mentor of mine once said, "If you choose to pursue wealth, do so wisely, and with good planning. Because once you begin accumulating wealth, there will be no shortage of unscrupulous people who will try to take it from you."
In my article, The Different Types of Corporations, LLCs, Partnerships, & More, I discuss the different business structures available to business owners in the United States (sole proprietor, partnerships, corporations, limited liability companies, and living trusts).
If you're only in the beginning stages of starting a business and don't own many assets or other businesses, simply setting up one business structure, such as an LLC, is usually sufficient.
But what do you do as your business flourishes and you begin to acquire assets?
Is owning only one business structure providing you with nearly 100% asset protection?
The answer is no.
The best method for asset protection is to combine the power of different business structures.
Let's assume a few years back you wanted to start a landscape company (I use this example because my brother and father own Modern Landscape, LLC). You formed an LLC which is to own the business and insulate you and your personal assets from any possible lawsuits that may occur as a result of your landscape company's work.
In this structure, if by chance someone from one of the landscape jobs got hurt, they could sue. However, because you formed an LLC to own the business, the person could only sue the LLC and attach a judgment to whatever it may own. If you were smart, the LLC owns nearly nothing.
Now let's say it's 5 years later and your business has flourished. You now own 2 rental properties, a big expensive house, stocks, lots of personal items (jewelry, clothing, art, collectibles, etc.), and your landscape company. You now own multiple safe assets and dangerous assets.
The dangerous assets would include anything with a higher risk of being able to create a situation in which someone may sue you. In this example, your two rental properties and your landscape business are your dangerous assets (though your car is probably the most).
As a result, you could structure yourself with the following business structure. You should note, this is not the best business structure to form.
The benefit to forming this business structure is if anyone wanted so sue you from either the landscape business side or the rental property sides, they can only sue your LLC and cannot touch anything outside of it (your house, stocks, collectibles, art, etc.). The drawback to this structure is if someone in Rental B gets hurt and decides to sue, they could attach Rental A and your landscape company to the judgment.
Adding Multiple LLCs
So how do you insulate each from the other? The answer is to form a separate LLC for each of your dangerous assets (but not your vehicle, explained later). So now our asset diagram looks as follows:
This structure is a MUCH better business structure for the entrepreneur that owns such assets.
Now, if that same person in the example above got injured in Rental B and wanted to sue, they could only sue the owner of that rental property (Rental B). Who's the owner? That one LLC which has nothing to do with Rental A, your landscape business, or your personal assets. Those are all insulated from this one lawsuit. Therefore, only your one rental property is at risk.
Even though this is a better business structure than the previous diagram, it still leaves you a bit unprotected. If you notice, your personal assets are floating around up there virtually unprotected from lawsuits (though protected from your dangerous business assets). The question then is, how do you protect those assets from all other lawsuits.
There are multiple possibilities but I will give you the one I prefer.
I like making use of partnerships - or more to the point, the Family Limited Partnership (FLP). An FLP by nature is used to protect family assets and is typically created by a husband and wife. The FLP should contain personal, non-dangerous assets: jewelry, clothing, art, stocks, etc. These items are unlikely to cause a lawsuit but will be insulated by the protection of the FLP from other judgments against you outside of the FLP. You should never include your most dangerous asset, your vehicle, in an FLP.
A FLP is composed of both general partners and limited partners.
In a typical FLP, the husband and wife would be both general partners and limited partners (general partners can be held liable and limited partners cannot). Their general partnership interests would only contain about 1 or 2 percent interest in the FLP while the remaining percentage held in their limited interest.
This is favorable because now only 1 or 2 percent of what's contained in their FLP can be attached to judgments and creditors (again, only general partners can be held liable).
Now that the FLP has been set up and contains all your personal assets, you can set it up so that your FLP owns all your LLC's, providing that the FLP only owns the LLC's and nothing contained in them. In other words, the FLP might own the landscape's LLC, but it does not own the landscape company itself. So now our diagram is almost complete and looks as follows:
Even Better Business Structure
The nice thing about FLPs is they are dynamic. Partners in the FLP can always sell or gift away their interests which makes the FLP a versatile asset protection and pass-down to heirs structure.
Adding a Living Trust
At this point, if you have formed the above business structure for asset protection, you have a pretty strong asset protected structure, but we still could do better.
There is one more piece of the puzzle we could to add to complete our diagram of nearly full asset protection - and that is a living trust.
As you can see in the diagram above, your house is included in the FLP. People can still get hurt on your property; a fire might start from your house and spread to another; etc. If such an occurrence happened, everything in your FLP could be at risk; therefore, we need to separate the house from the FLP and place it in its own legal entity called a living trust.
Now the trust owns your house, not you. But don't worry, you still control the trust (and get to live in, sell, rent, and everything else to the house). By doing this, our diagram now looks as follows:
Even Better Asset Protection Structure
By using the above business structure, you can reduce the risk of losing multiple assets to a lawsuit stemming from one of your other assets or business practices.
If you have noticed, there is one asset I have left untouched... and that is your vehicle or car.
A car is about the most dangerous asset you can own and should be left out of all structures you form. Of course if you own a construction company you might have to own a truck, but even that could be owned by something else. Your vehicle is the object most likely to be involved in something resulting in a lawsuit.
By being excluded from everything else you own, if you were to get in an accident and get sued, the person suing you would have nothing to go after; everything you own is owned by something else. As a result, the one suing you would likely simply accept an insurance settlement and be done with it.
In conclusion, by learning the tools at their disposal and a little smart planning, a wise entrepreneur will structure their assets in a way so that they may keep what they have worked so hard to obtain. Please keep in mind too that all I can give you is what I know from experience and what I've learned over the years in business. I am not (nor is anyone here at Nevada Incorporations Center) a lawyer and thus it is always wise to obtain advice from a lawyer in many matters.
Because this world never stands still, there have been small tweaks we have found to help increase your asset protection even more.
If you own a business or want to set up a business structure for asset protection, our partner BizFilings can get you set up today.
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