Editor’s Note: This is part two of a two-part series. Read part one here.
The experts at Beacon Exit Planning have observed seven recurring problems in their experience advising owners looking to exit their business in various markets from coast to coast. These are minefields that can derail owners from successfully achieving their inevitable exit.
Imagine working for 20, 30 or 40 years and losing everything you had in a lawsuit. Part of our plan is to protect what you have earned so it is there when you eventually exit. Exit planning utilizes strategies such as “asset insulation” to structure your business, making yourself less attractive to litigation. The purposeful restructuring of your assets in your business can provide you with an added layer of protection against creditors and predators.
Businesses are natural targets for lawsuits because of their perceived wealth and deep pockets. You can be blindsided and sued for events that you did not ever participate in.
According to the National Center for State Courts, nearly 20 million U.S. lawsuits are filed every year.
Most of these lawsuits are regarded as “frivolous,” meaning they have little merit, where the only intent is to intimidate defendants and seek cash settlements from the insurance instead of a trial.
Law firms are businesses and only pursue cases where there is a reasonable chance of financial gain. If there are no assets to pay the claim, there is a slim likelihood the plaintiff and attorney will initiate the case, even if there is a chance they will win. The best method of protection is, clearly, not to be sued in the first place.
Therefore, making yourself unattractive to lawsuits should be your first priority.
The strategy of asset insulation is to position assets and finances in such a way so as to make it difficult for a creditor to reach those assets, thereby reducing the chance of litigating.
The business owner must go beyond reducing risk and insulate his assets in order to reduce the incentive to sue. In the event a suit does occur, the asset insulation will limit or eliminate a plaintiff’s ability to reach the business owner’s assets.
There are numerous key points and benefits to remember about asset insulation. If properly implemented, it can provide business owners and affluent individuals with an additional layer of protection against predatory lawsuits beyond their existing liability coverage. These benefits include:
- Render a potential defendant unattractive to litigate by removing the financial gain incentive.
- Insulate major assets from predatory lawsuits and other creditors.
- Promote settlement, thereby leveling the playing field.
- Integrate with estate planning and tax minimization objectives without gifting assets or losing control of those assets.
6. Buy-Sell Agreements
Early in Beacon’s process when working with clients there is a review of personal and business documents. In many cases, we have uncovered provisions and structures that could be devastating to the business owner, the company and the family.
The risks oftentimes expose millions of dollars in unnecessary tax liabilities or structures that don’t support the owners’ intentions. This exposure is unrecognized by their existing advisers and must be confronted immediately before we even begin to draft the exit plan. For example:
• The document is underfunded or unfunded.
• Improper valuation formulas and definitions that can create ambiguities and confusion when the need to implement arises.
• Insurance policies that are improperly coordinated, creating potentially significant tax consequences.
• Documents that do not allow the remaining owner to take advantage of stock basis adjustments, a provision that could save millions of tax dollars.
Unfortunately, it is usually too late to change the course when the buy-sell is triggered by death, divorce, departure or disability. We have plenty of horror stories to support this scenario.
7. Primary Cause of a Business Exit Failure
Business owners have invested their life and time in building a successful business. Now these baby boomers are thinking about retirement. The critical question is: do you have a plan to capture more than 70% of your illiquid wealth trapped inside your business?
According to a Small Business Administration study, “At any given time, 40% of U.S. businesses are facing the transfer of ownership issue. The primary cause for failure … is the lack of planning.”
Most owners are just too busy running their business to take time to plan for their exit. They probably have a will they have completed, some estate planning, a buy-sell agreement and other uncoordinated planning, but not a clear exit plan. Smart owners find time to deal with the inevitable — they will exit their business, voluntarily (with a plan) or involuntarily. Procrastinating owners could wait too long only to liquidate for pennies on the dollar, leaving an irresponsible legacy for their spouse, family and community.
An exit planner can lead you through this process, discovering the various values and taxes often associated with transferring
Simply: If you fail to plan, then you plan to fail.