While we have found there are two main threats to your wealth; litigation and government intervention, the focus for today will be primarily on litigation. In 2008, there were nearly 1.2M practicing attorneys in the US alone and nearly 400K students in law school. Costs of litigation consumed 2.3% of the US GDP, or approximately $322B, roughly equivalent to Switzerland’s total GDP. This is an enormous cost that businesses and wealthy individuals must bear with no end in sight. In this issue, we will discuss the benefits of an LLC and how it should be a core component of your asset protection planning.
The Limited Liability Company, or LLC, traces its roots back to the German law of 1892 authorizing Gesellschaft mit beschrankter Haftung, or GmbH. Once established in Germany, other countries from all around the world followed suit. In 1977, Wyoming became the first US state to enact a true LLC act modeled closely after the 1892 German GmbH code. Today, LLC’s, or the local variation thereof, are the most widely used form of business ownership around the world. They are also the most widely misused.
Most entrepreneurs take great care in starting their company, but forget about the dual nature of asset protection and therefore neglect to properly structure their LLC. Not only do you want to protect your personal assets from the activity of the business, you also want to protect the business, and thus your income, from your personal activities.
This is where a properly structured LLC comes into play. If you are registering an LLC in the US to conduct business and/or to own assets there are the 3 main considerations;
- Register in a state that only allows creditors a charging order as the sole remedy by statute
- Register in a state that allows anonymous managers, or at least use a nominee manager
- Make sure you have a rock solid operating agreement
Step one is to register the LLC in a state where a charging order by statute is the sole remedy for a creditor to collect distributions from an LLC. There are several states that only allow creditors a charging order as the sole remedy, but not all of those states are a good choice due to other factors like excise taxes or capital values tax. Due to the nature of the charging order (in the proper state), creditors are only entitled to distributions, but cannot force a distribution, take ownership of assets, foreclose on business assets, or be granted membership interest in the LLC. This means if your assets are held in a properly structured LLC, your creditor can only gain rights to your distributions, but as manager, you can elect to withhold distributions to member(s) leaving your creditor with a tax liability. In some states, like CA, creditors can foreclose on business assets held in an LLC or even be granted a membership interest allowing them to gain control over the assets. You don’t want to register in those states.
Step two should be to register your LLC in a state that allows anonymous managers, or at least utilize a nominee manager. In most cases this veil of privacy is enough to keep the wolves at bay. Imagine getting into a car crash. Nowadays the first reaction of the ‘victim’ is the grab their neck or back and claim an injury. Of course their attorney will run a public record search for your assets to determine his ‘payday’. If there is no fat piggy bank to smash, in most cases he will not pursue you beyond the limits of your insurance. By simply making your assets invisible to public record searches, this puts up a significant roadblock.
And step three is to make sure your operating agreement is rock solid. Last week I discussed the operating agreement and what constitutes a good one (if you didn’t receive last week’s newsletter, feel free to send an email requesting the April 22 issue). I can’t tell you how many entrepreneurs that cross my path who either have no operating agreement all, or the one they do have is so inadequate, they might as well not have one. At least 90% of the operating agreements we review for clients are completely useless. Most are 7-10 page boilerplate agreements that offer no asset protection whatsoever. That is just not enough space to spell out a contractual obligation. Ours is approximately 70 pages. The operating agreement is the contract between you and your business and is the first thing the court requires for guidance in dealing with your assets. In the absence of a good contract, you are at the mercy of the court should you find yourself to be a defendant.
With proper asset protection planning, the LLC can be a very useful tool in minimizing your risk. There are many creative ways to use LLC’s for structuring your assets like using a Nevis LLC to own your domestic LLC thereby giving you an additional layer of protection and making your assets completely invisible. You can also use a combination of LLC’s to segregate business assets or strip equity from real estate using liens that you control. If you have any questions or would like to schedule your free 30 minute consultation, feel free to contact me either by email or phone.