In this article, we continue our discussion of BEI's Seven Step Exit Planning ProcessTM. We kicked off the series with a comparison of Exit Planning and succession planning and followed that with setting the business owner's goals and the critical importance of defining cash flow. Today, we move to one of the functions of Step Three: building and protecting business value.
In the third step of The Seven Step Exit Planning Process, we make specific recommendations to build and protect the transferable value of a business. There are a host of value-building recommendations we can make - depending on the strengths and weaknesses of a particular business - many of which are fee opportunities for us. But, if we over look protecting the assets of a business from a successful legal attack, we have committed more than just a fundamental and avoidable Exit Planning failure. We may doom our clients' companies.
A Few Business Planning Assumptions
- To engage in Exit Planning, owners must have a business to exit.
- The better the business, the easier and more successful the exit.
- Good businesses are not only profitable and well managed, but are proactive in minimizing operational and employment-related liabilities.
- Uncorrected business liabilities limit or prevent a business sale.
With those in mind, let's look at a case study that illustrates five basic actions you can take to protect your business owner clients' assets.
- Review the legal documents and business procedures related to employee relationships.
- Separate business operations from the bulk of the business' assets.
- Remove an owner's personal guarantees from business guarantees.
- Review and revise the casualty and liability coverage.
- Discuss personal asset protection tools.
Reggie Requests a Risk Assessment
Reggie set up a meeting with me out of the blue - or so I thought - until he explained that his biggest competitor was now out of business after losing an employment discrimination lawsuit. "What do I need to do to protect my business and my family? I am not about to lose everything I've worked for!"
As is the case for most owners, Reggie's business comprised the bulk of his personal net worth. If he lost the business to a successful lawsuit, he'd lose most everything.
Reggie continued, "Since I have a lot of business risk, I run a tight ship and operate my business as a corporation. I thought that gave me enough protection, but my competitor was a corporation as well. What's going on here?"
I agreed that operating as a corporation provides a layer of personal protection but pointed out that 80 percent of Reggie's wealth was concentrated in his business. "I don't know what your competitor did to protect his or her company, but I do know that we can do more to protect your company and your entire net worth from attack. Let's talk about protecting both personal and business assets."
In Reggie's case, an inventory of $5 million comprised the bulk of his company's net worth. Our goal was to insulate that asset from operational liabilities.
First, Reggie's attorney did what his biggest competitor should have done: brought all organizational documents up to date, created or reviewed employee handbooks, hiring and firing processes, employment agreements and qualified plan compliance documents.
Next his advisors separated the operation of Reggie's business from its assets. They severed operations - the part of the business likeliest to create liability exposure - from the bulk of the business's net worth (the inventory, cash, trade secrets, etc.). To accomplish this, they kept the existing corporate shell and formed a new, Limited Liability Company (LLC). The operations of the company resided in the LLC because, as the name implies, a LLC generally limits liability for acts of the LLC to the assets of the LLC. In putting operations in the LLC and leaving all other assets in the original corporation, if Reggie's company was attacked as a result of any of its operational activities, all of Reggie's other business assets would be sheltered. (Check with the tax and legal advisors on your advisor team to determine if this strategy is appropriate to your client's particular situation.)
Reggie's advisors then worked with Reggie and his creditors to remove his personal guarantees from every lease, promissory note, and financing agreement. While Reggie's guarantee had been vital during his company's start-up years, it required no more than a phone call or meeting to persuade most of Reggie's lenders to replace Reggie's personal assets with the business assets. Reggie's insurance advisor initiated a comprehensive review of the company's business casualty and liability coverage. Not surprisingly, this review uncovered several under-insured and non-covered risk areas.
Finally, Reggie met with his estate planning attorney to consider insulating some of his personal assets from creditor attacks. To do so, the attorney reviewed Reggie's personal liability insurance policies and used a variety of tools including trusts and retitling of property.
As an Exit Planning advisor, you are in the best possible position to coordinate and implement comprehensive asset-protecting solutions for your business owner clients. No business owner has all of the skills necessary to take all the asset-protecting actions described here and neither do their advisors - acting alone.The Seven Step Exit Planning Process gives you the platform, team and process needed to protect your clients and their companies.
In the next article, we will turn our attention to the three primary exit paths. We will discuss third party sales and the the most common result of a buyer-initiated sale process.