This article is on asset protection for your business’ assets (versus personal asset protection), specifically hard assets. I’ll address non-hard assets like IP in a later article. I’ve worked with a lot of businesses over the years that have hundreds of thousands, even millions of dollars, in hard assets. These were mostly construction businesses, so the assets were dump trucks, a fixed concrete plant, cement delivery trucks, tunnel boring machines, road paving equipment. The kind of equipment without which the business could not operate. If the equipment were lost through the legal process in a lawsuit, the business itself would have to shut down. Also, any equity in the equipment would be lost if the local constable were to sell off the equipment to satisfy the debts of the business.
Here I discuss several legal asset protection strategies a business with expensive assets can implement. Of course, like with all things I do for my clients, there is an accounting and also a commercial insurance aspect to the decision process. That’s why I always work with a CPA and commercial insurance agent when working for my clients.
WHAT IS ASSET PROTECTION
Any object that your business needs to operate successfully is an “asset”. Assets can vary in value, however, so the cost of implementing asset protection strategies has to be weighed against the value of the asset and the effect of its potential loss to the business. You’re not going to use these strategies to protect a laptop computer – the transaction costs of doing so will be higher than the value of the computer. But if your business owns a half-million dollar crane, you should consider these asset protection strategies.
So what do I mean by “asset protection”? Your business faces constant risk of loss of value, equity, and cash because of the nonstop exposure to various liabilities. Uninsurable judgements against the business can happen to any business. These include things like a landlord suing the business for failing to pay rent, or damage to someone’s property if a dump truck hits a building by accident.
Liability can be based on employment practices like discrimination, or failing to maintain workers compensation insurance. The business may be liable for breaching a customer contract for some reason; or conversely, for failing to pay a vendor sums due.
I often tell clients that nothing beats good insurance. However, many of the foregoing, and other business liabilities, are uninsurable. Your business has a bridge construction contract that has damages for delay penalties, and you’re unable to finish on time. There’s a huge chunk of potential liability there. No insurance covers it. Your business is unable to pay its lease payments due to a downturn in the economy. There’s liability there, but no insurance coverage.
Asset protection, then, is making sure that if the business faces a debt or other loss that it cannot cover by insurance, income, or retained earnings in the bank, the valuable hard assets of the business are not levied against (sold by the sheriff) to satisfy the debt, and remain “owned” by the business’ owners.
HOW DO WE SET UP ASSET PROTECTION
Setting up asset protection for your businesses’ valuable hard assets is actually pretty simple in theory. But the business has to follow through on all of these strategies for a court to honor the protection.
What I advise my clients to do, and of course help them with the legal part of the process, is to put the assets into a separate company which owns the assets, then lease the assets back to the business. When we do this, the “equity” is in the asset holding company; whereas the source of the revenue stream, and along with it the liability, are in the operating company.
You may have guessed that we have created a second company. In fact, they don’t even need to be “owned” by the same owners as the operating company. Little too complex for today’s blog post, but just so you know.
Here’s where most businesses fail, though: the owner decides that now that title to the assets is held in another company, the operating company is protected and that the two businesses can be operated as one. Registrations lapse, taxes aren’t paid separately, everything is operated as one company. That’s just wrong. Each business must be operated as a separate business: legal, accounting, tax, operations, insurance. Failure to keep them separate could result in a judge treating them as not separate.
HOW DOES THAT WORK IN REAL LIFE
First, your business needs to be big enough to make the associated costs worthwhile. That’s a business judgment to be made by the owners, in consultation with me, the CPA, and the commercial insurance agent of course.
Let’s set up a construction business – road paving. It is going to have 20 dump trucks, some asphalt paving equipment, and a few bulldozers. Let’s call it $2MM in equipment. We set up two companies: one to own and lease out the equipment; the other to lease the equipment and operate it when building roads. So first we have two separate companies.
That means separate state registration, bylaws, officers and directors, maybe even shareholders. Separate accounting, bank accounts, tax returns. Separate names, logos, phone numbers, web sites. Lastly, a formal, arm’s length, market rate lease for the equipment from Holding to Operating. You can see where the transaction costs start to add up.
What you wind up with is a company that is in the business of owning and leasing out heavy equipment. Its potential liabilities are close to zero because all it has to do is collect lease payments from lessees, and make payments to the finance company for the equipment. It contractually shifts the costs and liabilities of operating the equipment to the operating company via well drafted contracts. As a side note, the leasing company can even lease the equipment to a non-related entity if it needs to or wants to.
We also then have a company that builds roads. It owns next to nothing, maybe some shovels and a few pickup trucks. It leases equipment from the holding company and makes monthly payments. If this operating company incurs a liability that it cannot satisfy, the creditors are out of luck because there are no assets to be sold to satisfy the debt. In the meantime, if the operating company goes bust, the holding company can just repossess the equipment and lease it out to a third party. Using this strategy, some person or entity still owns the valuable equipment and can continue to monetize that ownership.
Next time you drive through a construction zone, take a look at the doors on the equipment. Often, not always, you’ll see markings like “This equipment leased to: [name of contractor].” That’s holding company, operating company at play.
For all your businesses legal needs, call me in Asheville, Hendersonville, Fletcher, Waynesville, and all of Western North Carolina at (312) 671-6453,
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