How proper planning can save your sinking ship
Part of the reason the Titanic sunk so quickly and so many lives were lost, was that the compartments that make up the hull of the ship were not completely sealed off from one another. When the iceberg tore open the first three compartments, water flooded, filled those damaged compartments and then began filling the rest of the ship. If those compartments had been sealed off from the others, the ship may have been able to stay afloat longer, proving safety for the passengers, at least until help could arrive, saving many lives that were lost.
What does this have to do with multiple entities?
As our businesses grow, and we acquire more assets, it becomes ever more important to compartmentalize those assets. I will give you an example of a type of business that is very prevalent in Laredo and along the border. The trucking industry. Imagine you have a trucking company and begin your business with a few tractors, and maybe some trailers. If the business is well managed, sales increase and more vehicles are purchased. Then having a terminal or yard of your own in order to build equity and eliminate rent going out the door every month would be a logical next step in growth.
With this example in mind, let’s remember that the U.S. is the most litigious country in the world. Trucking is a high-risk industry. Let’s say one of your drivers is negligent in his driving your truck, resulting in the death of a family. Your insurance company will provide a defense and may offer to pay the full policy limits to settle the case. But it might not be enough. If you began your business by forming a business entity like an LLC or a Corporation, your personal assets will be protected, but all the assets of the entity will be on the line to pay any shortfall the insurance does not cover. That means that all company vehicles (or the equity you have in them) and company property, can be sold to pay for the judgement. This can be a devastating result, even if your personal assets are not affected. Your way of making a living has been taken away and you have to start over from scratch.
Is there a way to reduce the risk? Yes, there is.
Again, using the initial example, I will show you that using multiple entities will provide protection, allowing you to continue moving forward with your business, without the total loss and devastation. As the business begins to grow and you acquire additional vehicles and equipment, you should form a new company to purchase the equipment, own it and lease it to your trucking company. In that lease, you would specify that the trucking company is responsible for all maintenance and damages. Your trucking company now pays your leasing company to use the equipment, it does not own any vehicles. When you purchase your terminal or yard, you form yet another company that rents the property to the trucking company. If there is an accident with your driver, they can only reach the assets of the trucking company. The trucking company does not own many hard assets, just some computers, desks, and other office equipment (if these things are not also leased). The vehicles (which are what make money for you) are then leased to a new company and will continue to produce income for you. The property is not exposed because it is in a completely separate company and a fair rent is paid.
This may sound too good to be true. It is not too good to be true, but it is more work to maintain the separateness of these companies. For this to work, you need to not just create the companies, you must insure that you maintain contracts, as if you were dealing with a stranger. You must maintain your entity minute books documenting all the inter-company agreements and transactions so you can defend the separateness of the companies. It is through the regular maintenance of the inter-company transactions and records that you insulate each entity from the other.