John Wyckoff, The Daily Record Newswire
As the U.S. economy continues to recover from the Great Recession, many Americans see starting their own business as a unique growth opportunity. In fact, according to the Global Entrepreneurship Monitor’s 2013 U.S. report, last year an estimated 25 million Americans started or were running new businesses.
Owning a business can be rewarding. However, it also comes with unique risks that could have far-reaching effects. Entrepreneurs pursuing their dreams and forging their own success are wise to put some safeguards in place to ensure that business ownership doesn’t upend personal financial planning.
Choosing the structure
A business’ legal structure can affect how much its owner pays in taxes, the amount of required paperwork, personal liability and the ability to borrow money.
For example, individual business owners have three primary options: operate the business as a sole proprietorship, form a limited liability company (LLC) or create a corporation. A sole proprietorship may be the simplest option, because a separate entity is not created. In this scenario, the owner can employ others, but he or she won’t be paid by the company.
Unlike a sole proprietorship, an LLC is a separate legal entity. Compared to a sole proprietorship, an LLC may offer more protection of personal assets if the business is sued. However, if capital must be borrowed, business lenders generally require personal guarantees from a small company’s owners, so owners would likely still incur personal liability. As for federal taxes, an LLC’s income is taxed to the owners individually and earnings are subject to self-employment taxes.
A corporation is a completely separate legal entity that transacts all business operations in its own name, including borrowing money and filing federal income taxes.
While this decision is very important, know that it’s not set in stone – an owner can begin as a sole proprietor and convert to another structure if needs change. It’s imperative that an owner seek professional tax and legal advice to help weigh all options carefully.
Knowing the value
Knowing the value of a business can help an owner access needed capital, create a succession plan and protect family from a large tax liability in the event of death. If an owner were to die unexpectedly, and the business was worth more than expected, the person may leave the family with a large tax bill.
Armed with an independent valuation of the business, an owner may be able to use insurance or other strategies to ensure sufficient liquidity to handle any estate taxes. Contact a valuation professional, who can assess the value of the business based on an analysis of various business and economic factors.
Protecting the business
Each business presents different risks, which is why it’s important to evaluate insurance options that protect against natural disasters, the sudden death of a key employee or other potential hazards. However, an absolute must for all businesses is professional or business liability coverage, which protects a business from acts of negligence in today’s litigious society.
General liability insurance protects business assets in the event of a lawsuit for something a person’s business did (or didn’t do) that caused injury or property damage. Liability insurance covers claims such as bodily injury, property damage, personal injury and damage from slander or false advertising.
Professional liability insurance, also known as errors and omissions insurance, is important if a business gives advice, makes recommendations, designs solutions or represents the needs of others. This type of coverage protects against claims that something a company did on a client’s behalf was incomplete or inadequate, cost the client money or caused harm in some way.
Succession planning
Letting go of the business someone has spent a lifetime building is a huge decision. It’s important to create a succession plan to ease the ownership transfer process and ensure that retirement goals can be achieved.
One may plan to transfer ownership to a family member or sell interest to an outside party. Another option is to sell ownership interest to employees through an Employee Stock Ownership Plan (ESOP).
Whichever plan is choose, it should protect the company’s value and competitive position, minimize potential conflicts among family members or co-owners, and create income for the exiting owner. A succession plan can also be an effective tool to minimize estate taxes if the company is public, because the owner can give his or her children up to $14,000 worth of company stock tax-free over several years, due to the federal gift-tax annual exclusion.
Much of business owners’ net worth is tied up in the business they have worked so hard to build. Carefully planning how to preserve and access capital is key to ensuring financial and retirement goals are met. An owner can prepare for the future by consulting with an experienced financial planner able to provide a comprehensive view of current and projected financial well-being.
People work too hard building their businesses to not benefit from them in the long term.
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John Wyckoff is a senior investment counselor with StanCorp Investment Advisers. He has nearly 15 years of experience handling personal financial planning and investments. Contact him at 971-321-8090 or at john.wyckoff@standard.com.
