Investing in a powerful tool and not using the tool properly does not make a lot of sense.
I know when it comes to running a business, it requires multiple hats to wear, and very often, you are off and running on 10 different projects, calls, appointments, presentations…and perhaps the very foundation of your business may be in jeopardy.
Here are the top costly mistakes I have seen made over the past 23 years:
If you started a business in your own name for a few months before you formed an entity, odds are part of what you did you completed as an individual, and you need to connect the dots to the new entity. If you filed a DBA (doing business as) with yourself as the applicant, that needs to be canceled and re-linked to the entity.
That means your entity needs to be the applicant, not you! If you don’t do this, you still are exposed to unlimited liability and filing a Schedule C with higher audit potential. The next point is to open a bank account in the business’s name, not just keep the account in your personal name. Use a business credit card in the entity’s name, not just your personal credit card, and keep track of expenses.
You will want to minimize the amount of debt that shows up in your personal name.
Update all affiliate programs, vendors with your new entity information, so any income is going to your business entity, not to your name personally.
Update your websites, business cards, letterhead with the new name of your business. Another important tip is to make sure your website complies. Most are not. I would recommend www.autoweblaw.com simple software with all the legal agreements you need on your website or blog.
2. Funding concerns. 95% of businesses fail within 5 years, and undercapitalization is the #1 reason.
The pattern I have seen is that small business owners hope for revenue to come in as the primary source of money to grow their business. What happens if your revenues are off or don’t come in at all? You may be working on that great new product, and all your e-mails go out, and no one converts. That is a real problem.
The key is to model success. Almost all successful companies do not use only their own money to grow. I know you know the concept, “OPM,” other people’s money, yet are you doing that? Are you only self-funding your business on your personal credit? Did you know that the business credit bureaus will start creating a file once the entity was filed?
They scan the Secretary of State’s records to create a file with any new filings. They look for the name of the business, the start date, and name of the officers/managers the address…
If you are not paying attention to how you fill out forms with the business address, business license, state forms, you can create disconnects in the database.
In one business credit bureau, NCP has spelled four different ways. The NCP part is the same, but one way has “Inc.,” one has, “Inc.” other has, “Inc” and the last one is “Inc.”
Did you notice the differences between the comma and the period? That created four different files! Don’t make that same mistake.
Unlike personal credit bureaus, business credit bureaus are very difficult to fix any mistakes. They have their own set of rules and are not set up for changes after mistakes happen.
This creates a problem for developing credit for your entity because you basically have one shot at the apple to get it right the first time. Banks and vendors are very interested in the financial strength of your company. Now joint venture partners can check you out for free to determine who is stable in your operation.
You may be losing business and not knowing it. It is really a must to be financially solid in your business, and your developing business credit is a must for your long-term success.
3. Safe and risk assets. Mixing asset classes is a major risk to your wealth that is unnecessary. A risk asset is an asset that would cause liability to your entity. That may be a business, real estate, equipment, again, anything that may cause liability to an entity.
A safe asset is one that does not cause liability to an entity, like cash, ownership of another company, investments…If your business falters and you need to rely upon your safe assets to recover the short term, why unnecessarily put your safe assets at risk? It happens all the time.
4. Not clear on who does what? A partner can help you grow a business quickly and destroy it even faster if you are not on the same page.
Very similar to being married. I have been married for 24 years with three girls, and it is a lot of work and requires meetings and discussions to do the best to be on the same page.
Business like marriage can be very exciting at first, and you really need to communicate well with what you are looking to accomplish. The fun part of the business is discussing how you will bring in revenue and all the possibilities that can happen with profits. The part that isn’t fun is the expense side of the ledger.
First, you must agree upon what is actually considered an expense: do that include cell phones, travel, meals…? What happens if revenues are way off, and there is not enough money to pay each partner, and you need more capital from each partner to keep it going? This can be a very uncomfortable problem.
It is best to presuppose the challenges ahead of time and see if you can calmly discuss them and develop solutions that make sense. If you can’t get to first base on the uncomfortable parts before you get started, that is a bad sign, and perhaps you should NOT be a partner. In fact, odds are the business is doomed to fail if you can’t get through some of these basic uncomfortable discussions from the start. Now, that does not mean your partner is telling their spouse the same story. That can and often does create more issues.
Having as much in writing from the start and a business plan in place makes the most sense. Almost ALL, not all, but close, partnerships that refuse to take the time to put things in writing fail. It is like clockwork. If anyone wants to start a business with you and refuse to put things in writing, run.
Most of the time, the only one that makes money in that situation is the attorneys after the partners sue each other. Take the time to be clear and put it in writing.
Learning how to transition from one company to two effectively is key to protecting your net worth.
When starting a business, you formed a separate legal entity to separate your personal and business assets, lower your risk audit, improve your chances for more business credit, and convey a more important marketing message.
As time goes on and your business succeeds, you will want to examine when it is right to form a separate legal entity to reduce liability exposure to your current business.
You may have a successful online internet business, and now you will introduce a new product to your list that may have more liability associated with it. An obvious one would be if you were looking to invest in real estate.
That would definitely be in a separate legal entity from your operating business. I often talk to business owners who have been in business for 10, 15, or 20 years and still operating EVERYTHING through one legal entity!
That can be very dangerous.
That means one lawsuit where the insurance company comes up with an excuse (also known as loophole) where they do NOT have to provide coverage. That means potentially 10, 15, or 20 years of hard work down the tubes!
Let’s assume you will add a second legal entity for part of your business to separate liability (or maybe you have a different partner on that one). Let’s cover the steps to make this a smooth transition!
The easiest way to look at this is to start over with the same steps you used to form your first company. The mistakes come in when you are tempted to take short cuts to save money (like not getting separate business cards, a separate business license).
Here are the steps to transition from one company to two for each company:
Trademark your business name
Form a separate legal entity
Obtain a separate LLC/Corp record book.
Obtain a separate EIN.
Open a new bank account for the new entity.
Proper capitalization from the correct owners (you, another entity, trust…)
Apply for a business credit card in the name of the new LLC/Corp.
Separate the expenses related to this new entity.
Apply for a business license http://www.businesslicenses.com/
Check with a local professional for other requirements, including other state filing requirements with the department of taxation or franchise tax board.
Establish a DBA name for this separate legal entity is required.
Establish a separate set of books. If you are using QuickBooks® or Xero, create a new company file for the new company.
Obtain separate insurance if required by the company
Establish a separate payroll account if payroll is required.
If the Entity is in Nevada and operating in another state, take the steps to foreign register in that state you are doing business.
Establish a 5-year business plan (so the entity is not considered a hobby plus a good idea to keep you on track anyway).
Establish new accounts with vendors for the new business. Even if your first company does similar services, it should be separated.
Establish a separate merchant account and the new entity.
Follow LLC or corporate formalities.
Avoid the commingling of funds.
The key is to be organized when you transition from one company to two. I know it would be easier to keep things simple, but simple and asset protection are inversely related.
Successful business people do not have all their business holdings in one LLC or corporation.
The key is to separate your assets and diversify your risk, just like you would diversify your investments for success.
One of the biggest mistakes I have found over the past 23 years is clients who sometimes have that false sense of security thinking they are totally protected with one legal entity.
Unfortunately, I have seen clients lose control of their companies, their personal assets, and even control of their operating business. The goal is to give you the strategies to plug up any gaping holes you may have in your shield of protection to your current and future assets.
Let’s review the basic’s. The first step is to separate your personal and business assets.
That means not operating as a sole proprietorship and forming a separate legal entity like an LLC. Nevada offers an extra layer of protection when it comes to protecting the entity veil and making it harder for someone to come through to your personal assets (assuming you were the owner of the entity).
The next step is to separate your “Safe” from “Risk” assets. Most take the first step to separate their “risk” assets by forming a separate legal entity. Shortly we will cover how to add more separation for your business.
Many forget to form a separate legal entity to protect their “safe” assets, like gold, silver, stock in the stock market (even your cryptocurrency)…where there is no direct liability to you. I believe the reason for this is most think they do not have enough safe assets to protect.
There is no magic number, like once you achieve $100K in safe assets (outside your retirement plan) you need to form a separate LLC. The key question to ask is, “How would you feel if you lost all safe assets to a lawsuit, or action by your creditors?”
If you had $40K of investments unprotected, that may be very important to you, if that is all your safe assets. Also, if you have ownership interest in a business, you may be worth millions, but if you own it personally or by your living trust (which is protected from probate, not liability) you may lose control of that safe asset also!
If you own real estate outside of your principal residence, that should be held by a separate legal entity. It should not be owned by your safe asset holding LLC or by your business operating LLC. To this point your asset protection structure should look like the following diagram below.
Notice that the living trust is owning the membership interest in each LLC, which is ok because the LLC provides the “charging order” protection which is a legal remedy that only (typically) allows the creditor to receive an “economic interest” in distributions from the LLC, not a management interest in the membership interest that controls the company. Now, with the charging order and the living trust connected, you have the best of both worlds.
I find that most seem to forget that if you form an S or C corporation (except in Nevada, which is the only state that has the “charging order” protection for corporations) and you are sued personally for something unrelated to the operating company, you could lose control of your entire company AND ALL the assets of the company, including ownership to your website, bank accounts or any other assets titled to that company.
Many seem to forget even who their website is owned by, which may be their biggest assets they lose control for any online marketer.
The key part is to ask the question: What would happen if my business was sued at the operating level? Do you have any type of business liability insurance to handle the first hit?
Most small businesses owners do not have any liability insurance. This means if your business is sued, your business is on the hook for all the legal fees to defend the business.
You could lose all the assets, domain names and bank account balances in the lawsuit. The good news is your personal assets should be protected because of the separate legal entity.
The second important question becomes: What would happen if you were sued for something unrelated to the operating business at the personal level? Would you lose control of your company? Would you have a new business partner in your company? This is why so many business owners are vulnerable as a corporation where you own the stock personally.
The first strategy involves the use of Single Member LLC’s disregarded for tax purposes to accomplish two goals:
1: to isolate liability to the main operating business (the main assets) and 2: to reduce your federal tax return expenses ( a single member LLC does not have a separate federal tax return due when it is taxed as a disregarded entity vs. an LLC taxed as a partnership would have a 1065 due federally which may be $400-$800 each).
In our example,e the husband and wife have an internet marketing business and realize they do not want all their eggs in one basket with their growing business.
It is typical if you are a speaker from the platform that would be a separate legal entity, also, if you put on your own events that would be a separate legal entity, and your coaching program would be a separate legal entity.
Each business has its own level of liability and forming a separate legal entity for each to isolate liability is a smart move. You may want all the profits and losses of each business to flow to one entity for tax purposes to simplify the tax structure.
Ideally, the individual owners will have a living trust set up for estate planning purposes to complete the planning. In this strategy make sure you separate each LLC for each business on all the websites, bank accounts, credit cards… to run them as separate legal entities.
Let me share a story that shares the purpose of this diagram below. A couple of years back, I had a client from Hawaii who had a very successful flooring business doing about $3 million per year in annual revenue. He had a partner and they operated under a Hawaii LLC taxed as a partnership.
The one partner was involved in a high profile divorce and the spouse (non-partner) engaged in the charging order, again the LLC as one of the assets involved in the divorce.
Even though the charging order protected the LLC’s assets, that spouse was able to subpoena all the business records of the LLC to determine if any expenses were hidden or going to other companies that the spouse had control of. This was very disruptive to the operating entity. Although the charging order did its job, this was disruptive.
When the partner finalized the divorce and moved to Las Vegas to open a similar business with his same partner, we added a protection layer at the ownership level.
Each owner formed a separate LLC to hold only safe assets, and the safe asset it would own was the ownership interest in the operating company. NOW, if either partner had a legal issue, personal, or another divorce, instead of a charging order against the ownership interest in the operating
company, it would be a charging order against the safe asset holding LLC.
This would insulate the operating business from any legal issues with any of the owners.
This same strategy works well with an investment group, with many owners, to require each owner to have their own separate LLC to own the investment fund’s ownership. This would help avoid any disruptions to the investment fund.
In this example, the flooring company may have different divisions, each with its own product line, and a single member LLC may help with the other structure for each division for liability reasons. See the diagram below.
In conclusion, a multi-tiered approach is a very powerful, yet underutilized strategy that can often be the difference between growing your net worth and not having any at all. It is not if you will be sued, but when. The more protection will help you keep more of your assets for you and your family.
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