How to reduce liability in your business activities
I was having lunch with a friend, who works as a financial planner, and he mentioned a client who had been sued and who had to pay out a large settlement that was based on the value of her business as a result. Ouch. The business owner kept a lot of cash in the business for a variety of reasons (it can seem smart to do that as business owner!), so the creditor was able to collect a much larger settlement than they would have been able to if those assets were held elsewhere.
There are ways this business owner could have reduced the risk of judgments to lawsuits while maintaining the necessary or preferred amount of capital in the business. Here’s one example:
Default business structure or something better?
The standard business structure for small businesses is one business entity. You have your LLC that owns everything and all business is conducted under the name of that LLC. That is not the ideal way to structure your business if you are in a lawsuit-prone business, or really any business that owns valuable assets.
Assets and business activities should be separated into different classes based on whether or not they are a source of liability. We often call these hot assets and cold assets (we’ve talked about hot and cold assets before, but in terms of real estate). Hot assets are a source of liability; cold assets are not.
Let’s look at a collection agency business. This type of business buys debts or notes and then works to collect payments from the debtors. The notes are very valuable, but owning them is not a source of liability. On the other hand, the action of collecting payments for those debts is very risky and is a source of endless lawsuits.
Even though these are two aspects of the same business, there is no reason these assets and business activities have to be inside the same business entity. A clever business owner would have an entity to buy and own the notes, and a separate entity to conduct the collection activities. That way, any lawsuits from the collection activities, are separated from the entity that owns the valuable notes.
This same logic can apply to different businesses and you don’t necessarily have to be a new business owner starting out. You can restructure an already existing business with a little help.
Colin Ley is a Seattle asset protection attorney. He is also the co-founder of LayRoots along with his wife, Shreya.