2015 is winding down, and if you’re like many business owners, you’re probably focused on setting goals and planning for next year.
Getting ready for the new year should entail more than just identifying new opportunities, though. Year-end is an ideal time to review where you stand in terms of protecting your business against unforeseen circumstances — especially when you are a small-business owner and have your personal assets tied up in the business. Just one misstep can cause not only your business to flounder, but when your personal assets, including your bank account or home, are linked to the enterprise, you could find that you’re facing personal bankruptcy, foreclosure, and worse when something goes wrong.
So as you plan for 2016, consider how secure your assets really are, and make some changes now to ensure that the worst doesn’t happen.
While there are many methods for protecting your assets, insurance is one that you should never overlook, and should always make room in the budget for. Many fields, including financial services, medicine, and law, require practitioners to carry errors and omissions coverage in order to maintain a license, but even if you aren’t required to cover your business against mistakes that you make, you should carry the coverage.
Don’t assume that a policy will cover both your business and the physical space in which it is located; for example, if someone slips and falls at your place of business, liability coverage will kick in, but that same policy won’t cover you if the building catches on fire and destroys all of your equipment.
The major benefit of carrying adequate insurance on your business is that in the event that something does happen, your insurance will cover the costs and you and your business will not be out the cash. In some cases, claimants can attempt to go after your personal assets, but usually, your insurance will cover everything. This assumes, of course, that your policy is adequate.
Carefully review all of the coverages you have in place and confirm that the limits reflect the current state of your business. The coverage you purchased as a startup probably won’t be enough protection after a few successful years. It’s also possible that your state laws have changed, so compare the policies you have and make any changes now before you come up short.
Choose the Right Entity
When you first started your business, how did you organize it? Many small-business owners opt for a sole proprietorship in the early days, since it’s ostensibly the easiest one to manage. However, when you are the sole owner of a business, your assets — including your personal assets — are vulnerable to lawsuits. Should your business experience financial difficulties, establishing a corporation also prevents creditors from coming after your personal assets to satisfy the business debt, in most cases.
That’s why many experts recommend that small-business owners establish an LLC or S Corp to keep their personal assets safe in the event of a claim against the business. Either scenario creates some tax implications, so it’s best to work with an experienced attorney or tax professional in order to make the right designation. If you are operating as a sole proprietorship, schedule an appointment to discuss your options and begin the process before year-end, so that the 2016 tax year is more easily manageable.
Consider a Trust
Another often-overlooked asset protection vehicle is the trust. If you are nearing retirement age, or you want to pass the business on to your children eventually, placing it in a trust can be a smart decision. Establishing a living trust does not mean that you have to give up the control of your business, as you can establish yourself as both the trustee and the beneficiary.
You’ll need to designate a backup trustee to manage the trust should you die or become incapacitated, but the benefit of a trust is that should you die, your business will not have to go through probate and it’s more likely that your wishes for the business after your death will be followed.
Like corporate structures, trusts do come with some tax implications, so it’s best to work with an attorney. It’s also important to note that when you set up a revocable living trust — the most common type of trust — your assets are still considered yours, and therefore subject to creditor collection. Certain types of trusts can keep your assets out of creditor hands, but they tend to be complex and not always favorable to the typical small-business owner.
Separate Business and Personal Assets
It’s small business 101: You always keep business and personal assets separate. But for many small-business owners, especially sole proprietors, that’s easier said than done. However, it’s important for many reasons, not the least of which is failing to do so can create some major headaches with the IRS. The practice of “commingling assets,” which is a fancy way of saying that you pay business and personal expenses out of the same accounts is often a red flag to the IRS, and can lead the agency to question deductions.
Failing to separate your business and personal finances properly also leaves you open to liability. Claims against your business will be satisfied by those accounts, leaving you without any personal assets. The need to separate assets goes beyond just maintaining separate bank accounts, though. When possible, if you open a business credit account, do so without tying it to your personal finances to avoid affecting your own credit.
In addition, if you have made any personal guarantees using your own property, such as your home, to gain financing, look into options for changing your arrangement to protect your property. After several successful years in business, you may have options for financing that weren’t available to you when you first opened your doors. If that’s the case, there is no reason to continue placing your home or other property at risk. As a bonus, refinancing might even reduce your overhead, allowing you to run your business more efficiently.
Owning a business is an inherently risky proposition. However, there’s no reason that you need to create unnecessary risk to your personal assets in order to run a successful enterprise. By reviewing your insurance coverage, business structure, and asset mix, and making the changes now, you can move into next year confident that even if the worst happens, you won’t lose everything.