The limited liability company (LLC) and corporation emerge as the two best choices of all the types of organizational forms available to the small business owner, 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. In most cases, the LLC will be superior to the corporation for the small business owner--although estate planning and tax ramifications need to be carefully considered.
However, even when the business is formed as an LLC or corporation, the business owner still faces an asset protection dilemma. Although operating your business as an LLC or a corporation protects your personal assets from the reach of business creditors, your business assets are still vulnerable to those creditors. The business can still lose everything that it has--which can spell ruin for a small business owner.
Often it seems that protecting the owner's assets against the claims of personal creditors and against the claims of business creditors are competing interests. Assets placed within the business form are vulnerable to the business's creditors, but protected, to some extent anyway, from the owner's personal creditors. However, assets kept outside of the business form are vulnerable to the owner's personal creditors, but protected from the business's creditors.
So, how can you protect all your assets from both business and personal creditors? Both objectives can be accomplished simultaneously through the proper funding and structuring of the business.
The ideal business structure consists of two entities:
- an operating entity that has possession of the assets, but does not own the assets (unless they are encumbered in favor of the holding entity or owner), and
- a holding entity that actually owns the business's assets.
It's true that this multiple entity approach takes planning and expert advice. And, once you adopt the multiple-entity approach, you'll need to balance the funding of these entities through both equity and debt, using leases, loans and liens.
To some extent, an operating entity's assets can be protected using only a single entity and leases, loans and liens, as well as through the use of a separate holding company. This is an example of multi-layered protection.
However, the simplest option--the one-entity approach--generally does not provide the flexibility and asset protection of the multiple-entity approach. It comes down to how willing you are to risk everything you work for in order to avoid a little bit of effort and paperwork.
Using multiple business entities
Using holding and operating companies is an asset protection planning strategy that helps to limit liability in your business structure. As noted earlier, the ideal business structure consists of an operating entity that does not own any vulnerable assets and a holding entity that actually owns the business's assets. With this structure, the small business owner can eliminate (or, at the very least, substantially limit) liability for both business debts and personal debts.
The operating entity conducts all of the business's activities and, thus, bears all the risk of loss. The owner's limited liability for business debts turns out to be no liability at all, because the operating entity contains little or no vulnerable assets, and the holding entity is not legally responsible for the other entity's debts. At the same time, the owner's liability for personal debts is reduced because assets are within the protective framework of a business form (i.e., the holding entity).
Advantage of using an LLC
This strategy is more suited toward the operation of two limited liability companies (LLCs), as opposed to two corporations, provided that the holding LLC is formed in a state that has adopted the Revised Uniform Limited Partnership Act view preventing foreclosure and liquidation of the business interest to satisfy a personal creditor.
Two corporations will not accomplish protect business assets from personal creditors because the law allows personal creditors to attach, and then vote, the owner's interest, to force a liquidation of the corporation. However, the statutory close corporation does provide another option. If it is formed as the operating entity and coupled with an LLC formed as the holding entity, you can achieve the same protections.
What are your options for creating entities
The individual owner can create and fund the holding entity. The holding entity can then create and fund the operating entity. Technically, the individual owns the holding entity, and the holding entity owns the operating entity. This is the approach taken frequently with corporations, where the operating entity is a subsidiary of the holding entity. However, the same approach also can be used with respect to the LLC.
Alternatively, the owner could personally create and fund both entities, so that he directly owns both entities. Or the owner could decide to use the one-entity approach, although this structure provides very little protection for your business and personal assets.
Tip
Thirteen states have adopted Series LLC statutes. These statutes present an ideal and unique opportunity to form all of the separate entities within a single LLC.
The better approach will usually be for the holding entity to own the operating entity. The multiple entities are then strategically funded to minimize vulnerable assets within the business form.
