Time to Read: 9 Minutes
Entrepreneurs take risk. They wager time, resources, and often their own money to make a business dream into reality. After the risky startup phase, however, many grow confident in the future of their company. And yet, hidden threats may still undo their hard work. Our goal is helping people live their best financial life between the two guardrails. For business owners, that means allowing you to focus on running your business with confidence and peace of mind, no matter what life holds.
In this article, we’ll cover 3 risks: gaps in your business structure, being underinsured, and sudden changes to management. For questions about your specific situation, please call our office to schedule a time to talk at no charge.
Get the Right Structure
Your business is only as secure as the legal structure you choose. This includes your entity (such as LLC or partnership), as well as how assets are held. Your business structure is your first line of defense against lawsuits and other liability claims.
What type of entity should I have?
Choosing a business entity is a complex question. There are many factors at play, including the legal, tax, and liability implications. We’d be happy to walk you through your options in more detail and work with your attorney and tax professional to find the best fit for you.
When it comes to liability, some business structures shelter you more than others. Others may give creditors access to your personal assets (such as your home or personal investment accounts).
Many small businesses are sole proprietorships or partnerships. While simple, they may expose you to liability risk. For more protection, you might consider an LLC, LP, or corporation.
Here is a summary of entity types and how much protection to expect:
- Sole Proprietorship: A sole proprietorship has one owner. It’s easy to set up and doesn’t need a formal legal entity. The downside is that it shifts all liability to the owner. When sued, your personal assets may be at risk if the claim is more than what you have in your business.
- Partnership: A partnership is two or more people agreeing to do business together. The liability usually falls on the owners. However, this doesn’t have to be the case. Some partnerships, such as a limited partnership (LP) or limited liability partnership (LLP), protect the owners.
- Corporation: A corporation is legally separate from the owners and so protects them from lawsuits and other liability. There can be one or more owners. Corporations come in several types, such as C and S corps, with different tax treatments. While sheltering from liability, a corporation can be costly to set up and operate.
- Limited Liability Company (LLC): An LLC is a popular vehicle. As the name shows, an LLC limits the owner’s liability. It’s popular because it is legally separate like a corporation but also has more tax benefits.
While important, legal liability is only one of many things to think about when choosing the right entity structure. Your entity impacts your tax bill and how easily you can raise money. You should also consider your industry. The right structure for law firm, for example, is probably not best for a coach.
How many entities should I have?
Many small business owners have one legal entity to hold all assets or lines of business. While this is convenient and easy, it exposes more of your business to risk. It allows liability to “bleed” from one part of the company into another. For example, if you own two unrelated business under in the same entity and one of them goes down, your second business may also be at risk.
We first need to understand “safe” and “unsafe” assets. “Safe” assets are those that have little or no risk of lawsuit, such as cash reserves. “Unsafe” assets, on the other hand, have risk. Examples include rental real estate where a roofer could sue for negligence, or a fleet of commercial vehicles that could get into an auto accident.
If “safe” assets are owned by the same business entity as “unsafe” ones, they are at risk. For example, a dental office may have the practice, a rental building, and cash reserves all owned by the same entity. If a tenant slips and falls in the rental building, the company may need to use cash reserves and profits from the dental practice for the settlement.
To protect your business, consider separate entities for each line of business or type of asset. In the example above, the dental office could create three separate LLCs for the practice, rental building, and cash savings. That way, if a tenant sues, the dental practice and cash are kept safe.
Keep in mind that there are tradeoffs to having multiple separate entities, including set up costs and the ongoing maintenance. It can complicate your business operations, so you’ll need to balance the asset protection benefits with this complexity. You may decide against getting a separate entity for a smaller asset.
What is the best structure for my small business?
There is no one “right” structure for all businesses. It all depends on your company and industry.
At BWM Financial, we would love to help you answer this question. We can partner with a trusted asset protection attorney to review your current structure. We can show you how much protection you have now, and where you may be exposed to more risk than you realize. If you need to change your structure, we will partner with your own tax and legal professionals, or introduce you to trusted ones in our network, to ensure your needs are met. Please reach out to set up a free consultation.
Your business structure is the foundation of protecting against liability. However, it’s not all you need. Most businesses also need insurance.
What type of insurance should a business owner have?
There are many types of commercial liability insurance. Here are a few major types:
- General Liability Insurance: Protects against accidental injury or damage to property. For example, a customer may slip on a wet floor at your restaurant, and you are found responsible for their medical bills.
- Commercial Umbrella Insurance: Protects against very big claims. When the cost is more than what your other policies cover, your umbrella will kick in and help pay the difference. In the example above, if the medical bills are $1,000,000 but your general liability policy only covers up to $750,000, the remaining $250,000 will come from your umbrella policy.
- Professional Liability Insurance: Protects from mistakes in professional services. This is also sometimes called Errors and Omissions (E&O) Insurance. This can include an accounting error at a tax preparer or an oversight from a lawyer.
- Worker’s Compensation Insurance: Protects a company when workers are injured on the job, such as a construction worker who breaks her leg because of faulty equipment breaking.
- Employment Practices Liability Insurance (EPLI): Protects from employment-related situations. This covers many different situations, such as a job candidate who felt discriminated against during an interview or a former employee who believed their termination was unfair.
What happens if you don’t have enough insurance for your business?
Gaps in insurance coverage can be costly. You may face a large bill from an unexpected judgment that drains your cash reserves. This can cripple a company or even, in the worst case, drive it to bankruptcy. As our San Diego clients have found, the risk is greater in more litigious states, such as California.
How can I protect my business?
The first step may seem obvious: get the coverage you need. However, this is easier said than done, especially when you don’t yet know what you need.
Examine every aspect of your operation to see where hidden liabilities may lie. An expert in commercial liability insurance can help you assess your business and point out blind spots.
Sometimes, liability can even come from outside your own practices. For example, toy company may acquire a factory only to find that they took on liability for defective products made there years ago. This is called successor liability risk.
Secondly, don’t “set it and forget it.” Even once you have the insurance you need, review your coverage regularly. Changes in operations, clientele, or staff may expose you to new gaps. Additionally, you may miss out if you don’t look at your options. Overtime, new insurance policies may become available that enhance your coverage or lower premiums.
At BWM, we help business owners get the insurance they need. We do not sell insurance policies, so we can provide objective advice without any hidden incentives. Our fiduciary duty is to help clients financially and educate them about the risks they may face. We can review your coverage and point out red flags or gaps. We can also introduce you to insurance experts who can give a more comprehensive review. They can also suggest new insurance policies to lower your premiums or plug holes in coverage.
Unexpected Changes in Management
While most changes in management are planned well ahead of time, life circumstances can force a change quickly. A divorce, disability, disagreement between owners, or death can be costly, not only personally but often professionally as well.
A succession plan (often called an exit plan) gives you the freedom to adapt, ensuring your wishes are carried out and business continues operating smoothly.
How do unexpected management changes affect a business?
Sudden, unexpected changes in management can strain a company. It can mean lower revenues, higher expenses, or both. Here are a few examples of what can unfold:
- A partner in an Encinitas law practice gets divorced. Since California is a community property state, her former husband demands a full 50% of her practice. She doesn’t have enough money, so her former husband drags her into court. After a long and costly legal battle, the partner has her wages garnished until her ex-spouse receives his 50%.
- The owner and lead surgeon of a Newport Beach practice breaks both wrists in a ski accident. While he can’t work, a temporary physician is hired, increasing operational costs. The surgeon also misses out on a once-in-a-lifetime opportunity to start a practice in a neighboring city.
- A small business owner passes away unexpectedly. The business doesn’t have savings to support his widow and family. The widow, without any prior business experience, wears herself out trying to run the company and eventually settles for a fire sale far below market value.
What can I do to protect myself and my business?
First, create a succession plan. A good plan is comprehensive enough to cover many situations and yet flexible enough that you don’t find your hands tied.
For many owners, succession planning is challenging. Small businesses in particular may not have key employees or family members who can take over if needed. There may also be disagreements between partners, stalling the discussion. If this is the case, an independent third party can facilitate your meetings to help all partners decide on a good plan.
At BWM Financial, we know how difficult these decisions can be. We regularly help business owners plan. Instead of overwhelming you with industry jargon, we start with the basics. When it comes to succession planning, we believe your personal planning takes priority. We’ll review your goals, both for your business and what you’ll do after the transition. We’ll then guide you through your options and help you determine the best fit.
Secondly, once you have a succession plan, you need to fund it. If your company doesn’t have enough savings, you may need insurance. It can help in many ways. Life insurance on partners is often part of a buy-sell agreement. Life insurance on key employees gives resources for finding a replacement if needed. A business overhead policy pays for expenses when an owner can’t work.
The team at BWM Financial has extensive experience working with business owners. We can take the place of a key employee on your team in managing your personal finances: helping spot blind spots, handling investments, cutting through the noise, prioritizing what is most important for your business, knowing when to bring in experts, and – most importantly – helping you live your best financial life. We also have a strong network of other professionals in the San Diego area who can make your succession plan into reality.
Contact our office today for a free consultation to learn more about our services and how we can help.