Armando (0:00 – 1:34)
Hello founder, you’ve built a successful business and now it’s time to think about that once-in-a-lifetime exit from your business. You’ve come to the right place. Here, you will hear business exit professionals involved in the buying and selling of companies talk about what you should know before you exit.
If you’ve never sold a business before, this podcast can be super helpful to you. I’m Armando, host of the Founder’s Guidepost. Enjoy.
If you like this information, please subscribe and share. Hi, Armando Roman with Axiom Founder’s Family Office in Scottsdale here today with, of course, Richard Keyt from the Keyt Law Firm. Richard, thank you so much for your time.
I think we’re going to have a really good conversation today on the family that owns a business and really the estate planning they need to be thinking about so that they can protect the family and protect the business. Richard, you are Gen 2 of your family-owned law firm. Your father is Gen 1 and he’s still there with you.
It’s great to be able to work in a family business like that and see that transfer of skills and experience. Part of why we like working with you is that before you became this estate lawyer who does all this lawyer stuff, is you were a CPA. I think that lens helps you add more value to the client because you might be able to see some things as you’re talking with them and hear things as you’re talking with the clients that maybe they’re just not thinking about, but you can add value to them.
Richard (1:35 – 1:51)
Yeah, thanks for the introduction, Armando, and the opportunity to talk about some estate planning issues and some issues relating to protecting your family business and why estate planning is an important component to that.
Armando (1:53 – 4:02)
It really is. Richard, we have people come in our office a lot who have businesses, built really fantastic businesses worth millions of dollars, and sometimes they just get so busy in their business that 20 years goes by and they haven’t done any estate documents. We want to make sure that we help protect that family and the business and protect that net worth.
That’s when you become critical in getting all those documents in order for them so that if anything happens that nobody expects an untimely death or something or that, then at least they’ve taken some steps to help the family be in a better situation after that. Let me see if I can get the outline. I’ll pull it up here for a second and then we’ll talk about that.
Give me just one second to pull that up. Here’s the outline that we’ll be going through. I’ll just touch on what this outline is quickly, and then I’ll ask you to go ahead and begin talking about it.
This is all about protecting your family and your business. The first section here, protecting the family. Richard, this is all about the estate planning, the estate documents that you will help them create.
The second section, or really maybe the section in the middle here, is all about protecting that business, having the right entity. If you have partners, what should you be thinking about? How do you retain the key employees?
The key employees are often what keeps that business value intact. It’s important that you keep those folks on board, separating the business units into maybe additional businesses for asset protection and having the right insurance. The very last section is all about protecting the family from the business, keeping those two separate so that each of them can remain healthier.
If something happens to one, it doesn’t spill over into the other. That’s the outline. Then let me get back to us on the screen here.
Richard, you can just begin talking about estate planning and estate documents.
Richard (4:03 – 7:05)
Yeah, sounds great. First off, I’ll discuss a little bit about what estate planning is. Estate planning contains two components.
One is planning for incapacity during your lifetime. Then the second component is transferring assets upon your death. Those are the two primary issues that we’re concerned with when creating an estate plan.
The reason why we want to plan for these two important topics is that if you do a plan, it simplifies life for your family and loved ones. So complications don’t arise, which could be costly and time-consuming and difficult to deal with and possibly expensive because you’re looking at having to potentially go to court, hiring lawyers, and just in general, making life more difficult for the family and the loved ones and the business as well. That’s why it’s important to create an estate plan.
When discussing what type of estate plan to create, people will typically hear two terms, a will and a trust. What are those documents and what are the primary differences between those documents? A will does not provide any protection for the person during that person’s lifetime.
It’s simply a way to transfer assets upon the death of the testator, which is the person who creates a will. In that will, it will provide the terms of who’s going to administer the decedent’s estate and ultimately who will inherit assets from the decedent. But the downside to having to create a will is that you could possibly need to have a probate.
And a probate is a legal proceeding in which a will would be submitted to a court and that court would determine whether or not the will is valid. And then once they do make that determination and admit it to probate, they would appoint what we call a personal representative, which is the same thing as an executor. It’s Arizona’s term for that.
So then that person would gather all the probate assets, which are those assets that remain titled in the name of the deceased at the time of their death. They would pay off all the final debts and obligations and then they would distribute those assets to the people designated in the will.
Armando (7:06 – 7:35)
And Richard, a question for you. So probate, I think that people often hear the word probate and it just seems like this ugly, scary word. And I think when people hear the word probate, they think they want to avoid it because they’re maybe not sure what it is, but they’re pretty sure it’s not really a good thing.
And is there a way that they can, how can they avoid probate or can they avoid probate?
Richard (7:36 – 8:43)
Yeah. So if you have a will, but you don’t want to go through the added expense of creating a trust, there are ways that you can title assets to avoid probate. And that’s done through what we call a pay on death transfer or a transfer on death designation.
So those two terms can, those two methods can be used to distribute assets at death without the need of a probate. So most banks and financial institutions will have that form on file, TOD or POD. You can fill it out and then you can designate the people that you want to inherit those accounts upon your death.
And then what would happen upon the person passing, the family would go into the bank, the financial institution, present a copy of that death certificate. And then those assets would be transferred over and there’d be no need for a probate.
[Speaker 3] (8:43 – 8:44)
Yeah.
Richard (8:44 – 9:16)
In Arizona, you can use what we call a beneficiary deed, which is a way to transfer real estate upon the death of the owner of the real estate. It’s a deed that gets recorded with the county and it designates who the beneficiaries are that will inherit that piece of real estate on their death. So there are ways that probate can be avoided if an individual doesn’t want to go through the added expense of creating a trust.
Armando (9:17 – 9:58)
Okay. But it sounds like the, like you said, there are ways to do it. It sounds like they need to make sure to have a conversation with you in advance, early, soon before anything does happen.
We’ve had too many widows walk in our door that the planning just wasn’t done. And it’s bad enough to lose someone that you love and it’s worse or extended when there’s all this legal complication because things weren’t set up in advance. It just makes it worse on the surviving spouse and it makes it worse on the family.
So having that conversation with you, you can obviously guide them as to which direction might be the best route for them. Right?
Richard (9:58 – 11:05)
Yeah, exactly. And to tie it back into the business context, what happens if you have a successful business owner whose family really doesn’t know what’s going on with the business? It’s there, it’s successful, but they don’t know who the key employees are, who’s responsible for running it.
And now all of a sudden you’re faced with the death of that business owner, who do they go to? And how much time is it going to take to get somebody put into a position of authority where they have the legal authorization to make decisions with respect to the business. And it can add up and it can be both, like I said, timely and expensive, and it could ultimately maybe really hurt the value of that business.
So it’s important that if you do have a business and you don’t have any estate planning documents in place, you could really be putting your family and your business at risk if something happens to you.
[Speaker 3] (11:05 – 11:06)
Right? Right.
Armando (11:09 – 11:18)
So, oh, sorry. Go ahead, Armand. I was just looking at the outline to see what in that section we hadn’t talked about, and there’s a few things still.
Richard (11:20 – 13:32)
Yeah. So we talked a little bit about how estate planning affects inheriting assets. Now, the next topic is that we’ve addressed a little bit on the will.
What is a trust and how does it differ from what a will is? So a trust is a document that allows you to transfer assets into it, and then it allows you to designate beneficiaries to inherit those assets upon your death. So the lifetime component to the trust is if you do become incapacitated, you have a successor trustee in place who can use those assets of the trust to pay your medical bills, living expenses, and so forth without having to rely on a power of attorney, or in the worst case scenario, having to go through the court and get a conservatorship, a conservator appointed to handle your affairs.
So that’s the added benefit of a trust is it provides protection for you during your lifetime. So again, bringing it back to the context of a business, if something happens to you and you have a successful business, now you have this trust in place which owns your business. Therefore, your successor trustee can now step into your shoes right away and take the steps necessary to protect the value of the business so that it doesn’t hurt you and your family.
So that’s the benefit you get to creating a trust, that the trust provides you rather than creating a will during your lifetime. So it provides that protection for your incapacity, and it makes it much easier and quicker for your family to help you in the event that you do become financially unable to manage your affairs anymore.
Armando (13:32 – 14:15)
Right. And then that trustee, since it’s already, once it’s defined inside those trust documents and the trustee now has authority and control, businesses can drop in value very, very quickly once a key person passes. So it sounds like having that document already queued up and identifying who is the trustee, the trustee can quickly step into the company and help preserve that value for the family, maybe hire a new CEO, hire a new general manager, or do whatever needs to get done so that the value can stay, the customers can still be there, their employees can still be there.
Otherwise, it could very, very quickly start to fall apart and be worth nothing.
Richard (14:16 – 14:53)
Yeah, exactly. So, you know, trust is very important when somebody has a very successful business that’s thriving and doing well. And not only that, you can tie the trust into your company’s governing documents.
So it’s made clear on who’s the key employees are, who’s in management. So you can really tie that up together nicely and ensure a smooth transition, both on incapacity during lifetime and after that.
[Speaker 3] (14:55 – 14:58)
Okay. Wow. Wow.
Okay.
Richard (14:59 – 15:26)
And then to provide some more just general backgrounds on trust, typically you’ll hear many terms thrown out when it comes to trust. You’ll hear irrevocable trust, living trust, family trust, inter vivos trust. Those are all synonymous terms for what I refer to as irrevocable trust.
[Speaker 4] (15:26 – 15:26)
Okay.
Richard (15:27 – 16:58)
Trust that is created, you create during your lifetime, which you retain total control over. So it can be amended at any time. It can be revoked or terminated at any time, so long as you still have your mental capacity.
And this is the primary trust that people create for normal estate planning purposes. So the incapacity planning, and then the transferring of assets upon death planning. So that would be your standard revocable trust.
An irrevocable trust is used more for asset protection planning and estate and gift tax planning. So from an asset protection standpoint, you can fund an irrevocable trust with some third party as a beneficiary. It can’t be yourself.
So it could be a family member, a friend. And once that trust is funded, those assets in that irrevocable trust can’t be reached by any potential creditor of the beneficiary or even yourself because you no longer own those assets. You’ve given it to this new trust and therefore any claim that may arise against you or that beneficiary, the assets of that trust wouldn’t be liable to those claims.
Armando (16:59 – 17:39)
And so then Richard, when you set up that irrevocable trust, you said the common one is the revocable. And I have trouble with that word. I don’t know why, but I want to say revocable because I can pronounce that a bit better.
But that revocable one is the common one that people get in their estate documents when they get their estate documents done. The other one, the irrevocable is really there for asset protection where the person is taking assets that they have and they’re taking them and giving them into this trust. And now they no longer own them and they no longer control them.
It’s something that’s completely separate from them.
Richard (17:40 – 17:45)
Exactly. Yeah. And then, oh, sorry to go ahead, Armando.
Armando (17:45 – 17:52)
I was going to say for asset protection, then that’s when those irrevocable trusts come into play. Right?
Richard (17:52 – 19:06)
Exactly. Yeah. And then the second component, like I said a few minutes ago, is for estate and gift tax purposes.
So people will create irrevocable trust if they have a taxable state and then make gifts to those trusts. And by making gifts, they transfer those assets out for estate tax purposes such that when they die, it won’t be included and therefore the estate tax liability will be lessened. So that could be a component possibly used in business planning.
If you have family members that are involved in the business and the business has substantial value, maybe you’ll want to set up an irrevocable trust to give interest in that company to the family members that are operating it so that you can transfer the value of that business out of the owner’s estate and minimize the estate tax burden on the second generation of the family who’s now running and ultimately going to own that business.
Armando (19:07 – 19:16)
Okay. Okay. So maybe you can touch on powers of attorney, what those look like and why people should care about them.
Richard (19:16 – 21:06)
Yeah. Powers of attorney are very important. And the reason why they’re important is because the first element of estate planning is planning for your incapacity during lifetime.
So we want those documents in place because if they’re not in place and you’re no longer able to make decisions for yourself, both financially and from a welfare standpoint, there’s now nobody alive who can handle that responsibility. Since you’re no longer able to handle those decisions, somebody has to be appointed by a court to do that for you. So in Arizona, we call that a guardian and conservator.
So they would then be appointed by a court after a court declares that you no longer are competent to do so yourself. So that’s an expensive proceeding. And it’s also stressful because you have to go before a judge, a lawyer needs to represent the incapacitated person, a lawyer needs to represent the guardian and conservator.
And then once that process is complete, there’s annual filings that must be made with the court. So it’s something that can be easily avoided by creating a healthcare and durable power of attorney. In those documents, you’re taking the court out of the picture and you’re designating people yourself that you feel would be responsible and able to take care of you in the event that you do lose your capacity.
Armando (21:08 – 21:57)
Okay. Great. And it seems like, Richard, sometimes we’ll meet people, business owners come in and they’ve got estate documents, but they did them 20 years ago.
And life is very different today. They’ve got a lot more assets, a lot more wealth, a company worth a lot of money. The little kids are all grown up and moved away.
So things have changed a lot since the day they got those documents done. But part of what we will see sometimes too, is they get the documents done and they feel good that they’ve got documents done, but titling of assets isn’t always changed after those documents are done. Maybe you can talk about why that’s important and why that is part of that whole estate planning process.
Richard (21:58 – 23:32)
Yeah. It’s important in the trust context because if the trust isn’t funded, that can present complications. So funding refers to the titling of assets, the changing of the ownership of those assets from the asset owner to the trust.
If it’s not done, then you could be in a situation where you have to rely on a financial power of attorney, which isn’t always the greatest situation because sometimes it can be difficult to get third parties to honor those. So the more transferring of assets you can do into the trust while you’re able to do so, the easier it is to take care of you in the event you lose capacity. And also, if the assets aren’t titled into the trust and you die, now a probate is required to collect those assets and then transfer them into the trust at the closing of the probate.
The titling of assets is important because that’s what makes the trust effective. And then secondly, if you don’t have a trust, if you do the TODs and pay on debt designation forms, you can avoid the probate process and not have to potentially rely on having to go through probate with a will.
Armando (23:32 – 24:02)
Okay. And then one last thing about this section, if we can just touch on that, people will sometimes, they don’t know who they want to have as their beneficiaries. They don’t know who they want to have as their guardian or their conservator.
And if they don’t know who they want, it seems like it’d be better for them to pick somebody now and then change it later if they decide to do that. When they make that initial decision and pick somebody, they can change that later, right? Or no?
Richard (24:02 – 24:23)
Yeah. Yeah. As long as they are still able to do so.
So as long as they still have their capacity. If they’re incapacitated, then it becomes not likely that they’re able to do that. But as long as they’re still with it mentally, they can change those documents at any time during their life.
[Speaker 3] (24:23 – 24:24)
Okay. Great.
Richard (24:25 – 24:57)
And then I did want to touch on one other asset protection component, Armando, with creating a revocable living trust. So one of the benefits that your family members receive in the way that we draft our trust is we provide that the inheritance of a beneficiary is left to that beneficiary in trust. The beneficiary receives lifetime asset protection from that gift.
[Speaker 3] (24:58 – 24:58)
Okay.
Richard (24:58 – 25:43)
Law deems that the beneficiary never owned it. It was given to them in trust rather than given to them outright. And another added benefit under Arizona law, the beneficiary can still act as their trustee and retain total control over those assets and not have to worry about creditors coming after them.
Those potential creditors could be anything from a bad divorce. It could be a lawsuit, a bankruptcy. As long as that beneficiary keeps those assets titled in their separate trust, it’s protected from any future would-be creditor.
Armando (25:44 – 26:05)
Wow. So with your estate documents, you’re helping that business owner in the family. But then when mom and dad’s time comes and now they’re gone and the assets then transferred to the kids, the adult kids, being that they’ve transferred inside those trusts, the assets are still protected.
Richard (26:05 – 26:14)
Still protected, yeah. And then it’s also protected from the beneficiaries on bad deeds.
Armando (26:15 – 26:34)
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Richard (26:35 – 26:53)
If you have beneficiaries who aren’t responsible with money, maybe they have substance abuse problems, maybe they have a bad spouse that they want to protect the money from. So by leaving it to them in trust, you can protect the beneficiary from themselves as well.
Armando (26:54 – 27:43)
Wow. Okay, great. So let’s move on to protecting the business.
That’s great context, Richard. You mentioned a lot of things in there, in those estate documents that are kind of, I’d say, foundational, whether you have a business or not. But when you have a business, it seems to me it’s even more important, especially if that business has substantial value, just protecting it.
So the second section is protecting the business. And a few things in here about the first section is really about entity. And there are lots of types of entities.
And people often hear about LLCs, and they will select that or be guided towards that. Maybe you can touch on the entities and what are they really doing for that business owner? Why does it matter?
Richard (27:44 – 30:44)
Yeah, that’s a great question. So there are three entities that provide the owners with asset protection. You’ll hear of a limited partnership, maybe a limited liability partnership, then you have your corporation, and then you have a limited liability company.
The limited liability company in the last 20 or so years has become the entity of choice because it took the best aspects of the partnership and the corporation and combined them into one entity. So with the corporation, the corporation has become disfavored recently because there’s a lot of formalities that need to be followed. You have to hold annual minutes.
In the state of Arizona, you have to file an annual report. And all of that has to be done. And if it’s not, you could potentially lose the protection that the corporation offers.
So it makes it more likely that the corporate veil will be pierced. You’ll hear that terminology used often in the context. And what that means is if you’re sued and you haven’t been following those formalities, the court will disregard the corporate shield and allow the potential creditor to collect from your personal assets.
And with respect to the partnership, the partnership provided joint and several liability among all the partners. So they created the limited partnership, which still a general partner has full liability for the activities of the partnership. And then the limited partners are restricted in what they can do from a management perspective.
So the LLC came about and they said, well, we’re going to take the beneficial aspects of both the partnership structure and the corporation structure and combine them into one entity. And that’s why people now are primarily forming LLCs because you don’t have all those corporate formalities you need to follow. You don’t need to file an annual report with the state here in Arizona.
You don’t have partners who share full liability for the activities of the business. And then you don’t necessarily always have limited partners who can’t participate in management. So it combined all of those things into one entity.
And that’s why most people nowadays prefer the LLC. And additionally, the LLC is nice because from a taxation standpoint, it’s flexible and that the members of the LLC can choose how they want that LLC to be taxed from a federal income tax perspective.
Armando (30:44 – 31:18)
Okay. And if they don’t have, sometimes you’ll meet business owners who don’t have any type of entity at all. They don’t have that legal entity, the LLC, the limited partnership corporation.
They don’t have any of that. They just operate as what’s called a sole proprietorship. And when I see that, I’m always a little bit surprised, but maybe you can talk about the separation between the business and the family when there is no legal entity that separates them.
Richard (31:19 – 32:57)
Yeah. So in that situation, you have a potential disaster that could unfold because by operating a business, there’s inherent liability. And as the business increases in risk, depending on what you’re doing, that risk can increase substantially, which makes it likely that if you do get sued, then your personal assets are going to be at risk in that lawsuit.
So that’s why it’s important to have some form of legal organization. And to take that a step further, the worst case scenario, we touched on the sole proprietorship aspect, but there’s also, sometimes I see people that have what we call a common law general partnership. So that’s when two or more people carry on a business with the intent of making profit.
In that situation, if one partner does something bad, the other partner has joint and several liability, meaning they assume full responsibility for each other with respect to that particular business and their assets could be at risk. So those people that are with general partnership, those people need to form some sort of legal organization to protect themselves from the activities of the business and then also from the activities of each other in the event that they do something wrong when carrying on behalf of the business.
Armando (32:58 – 33:16)
And so in that example, if something did go wrong in the business and something blew up, then both of those families, whatever the families own are at risk and they now might need to hire attorneys to try to protect what they have. But at that point, it might be too late.
Richard (33:17 – 33:25)
Exactly. Yeah. And one partner could pick up a hundred percent of the bill and the other partner might not pay anything because they don’t have the money to do so.
Armando (33:26 – 34:08)
So yeah, it’s really important. Something like the worst of all worlds. Yeah.
It just drills home the point they need to have that business entity on there. And what about partners? Partners, like you mentioned a good example about partners that have a common law partnership.
When there are partners like that, they can put certain things in place to protect them. And often there’s a partnership agreement or some kind of a written agreement that says, okay, you’re going to do X and I’m going to do Y and it’s a written agreement. Maybe you can touch on what that really does and how that can help protect the business and protect each of those partners as well.
Richard (34:09 – 36:16)
Yeah. The governing document of LLC, we’ll go with an LLC here is what we call an operating agreement. And that operating agreement is a very important document because it governs the rules on how that LLC is managed and operated.
Now, if you don’t have an operating agreement, the state has an operating agreement for you. And there’s provisions within the state statute that don’t make sense from a general business perspective. For instance, everything is done under the state statute per capita, meaning the numbers of members that an LLC might have.
Well, what if you have an LLC where you have two members and one person put in 90% of the capital and the 90% member thought they should have 90% of the votes. Well, not under the state statute, if you don’t have an operating agreement, those people are going to have equal say and how that business is managed. So that’s why it’s important to have an operating agreement because you want to opt out of those default rules with respect to a multi-member LLC.
Now, in a single member LLC context, maybe it’s not as important because it’s just you, but it’s still good practice to have one because it shows that you’re treating this business as a separate and distinct entity apart from yourself. So it can be used to prove if you’re ever sued that it’s not you, it’s a separate business. Look, I have this contract to prove it.
So it could be helpful in that scenario as well, even though you don’t have some of those nonsensical rules as it relates to multi-member LLCs.
Armando (36:17 – 36:43)
Okay. Yeah. And the last section of our agenda is talking about that separation.
And sometimes you hear the word commingling business assets and the personal assets, and you really use them all as kind of your personal checkbook. Yeah. That’s horrible.
People shouldn’t do that. And when IRS sees that, they swing at you with a big stick because that shouldn’t be happening.
Richard (36:44 – 38:08)
Yeah. Yeah. And then to touch on another important document, we talked a little bit about the operating agreement, and then there’s also a buy-sell agreement, which is important in the context of a multi-member LLC and estate planning, because the buy-sell agreement, the primary event that it’s designed to protect for is the death of a member or partner.
So if you have a buy-sell agreement in place and a member of that company dies, then that buy-sell agreement will kick in and determine what happens to the interest of the deceased member and how that interest gets bought out by the estate of that deceased member so that the surviving member can carry on without having to worry about dealing with heirs who may be difficult, who don’t know anything about the business, or if it’s a business where there’s a lot of human intensive capital that both members were expending during their lifetime, and now you’re in a situation with difficult heirs who don’t want to work in the business, but they’re entitled to profits. You don’t want to be in that scenario and you don’t want your business partner to be in that scenario.
So that’s why it’s important to have a buy-sell agreement.
Armando (38:09 – 38:45)
Okay. Yeah, that makes sense. And when we see those, we often see those funded with a term life insurance policy, which is typically fairly inexpensive if people are in decent health, but when the company becomes worth millions of dollars, then people don’t typically have a million or millions just sitting in cash in the bank, but that’s when that term life insurance policy to fund that buy-sell agreement can be very, very helpful for the company and for the surviving partner and for the deceased partner’s family as well.
Richard (38:45 – 39:19)
Yeah, that’s a great strategy. And the other reason to have it too is to protect your family. I mean, if you have a business, you have a business partner, but your family may not necessarily know what you do in that business, how to operate it on a daily basis, by having that buy-sell agreement, the two of you or more, however many people are involved in that business are protecting their family by creating this document to tell them what to do in the event of one of their deaths.
Armando (39:19 – 40:20)
Yeah. Yeah, that makes sense. Let’s talk about then for protecting the business about retaining key employees.
Often successful businesses have key people that are part of that business. And if you lose one while you’re still running the business, well, it might take time, but you can get someone else to replace it. But if the owner dies and the key people wonder what the heck is going to happen, they need to look out for their own families and they’re going to jump ship if they think that’s in their own best interests.
So when it comes to retaining key employees, what I’ve seen before are sometimes deferred compensation, sometimes company pension plans, key person life insurance policies, and those are all designed to keep that management team, that executive team there and help the company get through some of those rough spots that might come along the way. And what are your thoughts about that?
Richard (40:20 – 40:51)
Yeah, those are all great strategies to incentivize employees to stay. And then also there’s added tax benefits that the owners can utilize by creating those types of plans to benefit themselves as well. So those are definitely things that business owners should have in place for their employees to not only treat them well, but to incentivize them to want to work harder, stay and contribute to the growth and success of the business.
Armando (40:51 – 41:25)
Yeah. And then in the context of estate planning, a family that owns a business, typically most of their wealth is in that company. So if that’s where most of the family wealth is, then they really need to take a look at the business from that perspective and take care of those documents and get those things in place so that if something happens to the owner of the business, the family is going to get at least a good portion of that value into the family on the death of that business owner.
Not get all of it, but at least if they can get a good chunk of it, the family is going to be better off.
Richard (41:25 – 41:27)
Exactly.
Armando (41:27 – 42:26)
For sure. Okay. What about sometimes a business operates all kinds of different lines of businesses and sometimes we’ll see that and we’ll help the owner understand that maybe you need to spin up a whole separate business unit because you’ve really got two different businesses under one company shell.
And if something happens to one of those business units, it could certainly potentially destroy the other one and you’d have nothing. So often when we’ll see that, we’ll see two separate businesses, two separate LLCs or two separate corporations, but just separating them for the same reasons we’ve been talking about separating the business as an entity from the family, just so that it puts liability, isolates it in different buckets. So if something happens to one thing, it doesn’t take down the whole ship.
Richard (42:27 – 43:05)
Exactly. And to add on to that, it’s also important when you have valuable assets, like real estate, patents, other types of intellectual property, you want to make sure those valuable assets are held outside of the operating business. Because if there is an issue with the operating business, you don’t want that valuable asset to be at risk in the lawsuit.
So by creating separate entities to house those assets, you protect them from future liability with respect to the ongoing operations of the business.
Armando (43:06 – 43:26)
Yeah. And sometimes I’ve seen companies that have a lot of heavy equipment, but the equipment into a whole separate entity, just for exactly that reason, just to separate that out, get that value into one separate bucket, and then lease those back to the operating business as a form of asset protection.
Richard (43:27 – 43:28)
Yep, exactly.
Armando (43:29 – 44:50)
Okay. So let’s talk a bit about insurance when it comes to protecting the business. There’s so many types of insurance that it can get really overwhelming very, very fast.
And we had a client recently who has a business who didn’t have, they were in, they were delivering some form of health care, they didn’t have the right insurance for their business. So they needed to get with the right type of insurance company or agent to help them understand what they needed, so that they could really keep the business safe and keep that value safe for the family. And the insurance can be things like what’s called property and casualty, you know, insuring the stuff.
It can be commercial liability insurance, it can be professional liability insurance, but lots of insurance is there that are there for a reason. And you can certainly do insurance overkill. But it seems like every business should at least have some kind of commercial insurance policy in place for that business.
And you talked about protecting, you know, the LLC to protect that business. And we look at insurance as another layer of that protection for the company as well.
Richard (44:51 – 46:05)
Yeah, I always like to say insurance is your first line of defense. From a collection standpoint, it’s much easier for a lawyer to collect from an insurance company than it is for that lawyer to try to proceed against you personally, because then you’re talking about all sorts of judicial remedies that a potential creditor would need to exercise. And that can be costly and time consuming.
So if you have insurance in place, and in the worst case scenario, it has to pay out for some sort of loss, you know, it’s unlikely, potentially, that creditor would continue to proceed against your personal assets and other assets, because then they have to spend money to do so, which may not make sense economically. And it could be difficult. So insurance is always your first line of defense.
And it’s important to find, you know, a good advisor that’s well versed on the different types of policies and what you need to adequately insure your business and, you know, your other assets.
Armando (46:06 – 48:04)
Yeah, yeah. And it really depends often on the type of business that you’re in, what type of company, what is your business, and the person has to understand what is that business, what are the risks, and what is necessary in that company to protect from some of those potential risks. Okay, so let me go back here for one more quick second, just pull up the agenda so we can remind ourselves what’s on this agenda.
And on this agenda, you can see the, we just went through that protecting the family section up on top, protecting the business there in the middle, we talked about that as well. And now we’re looking at that last section, protecting the family from the business. And we’ll talk about a few things there and others as well.
But I just wanted to pull that up to remind, really remind us and get the big picture on what the conversation is about. And then let’s continue talking about that then. So for protecting the family from the business, you know, I’ll go back to your to your former CPA background, Richard, because as a CPA, one of the things that that one of the key words in that space is commingling of assets.
And IRS does not like commingling of assets. So if you have a business and that business has a checking account, but the owner uses that checking account as his or her personal checking account to buy groceries, pay for vacations, pay for all kinds of stuff that are not business related. That is what’s called commingling.
And worst case, IRS can come take a look and say, well, you didn’t respect the business entity. Therefore, that were to use those terms used earlier piercing the corporate veil, that comes into play. It’s as if there was no business entity at all.
And therefore the business and the family are one in the same, and everything is at risk.
Richard (48:05 – 49:22)
Yeah, and to take it a step further, they could claim that those are personal expenditures and not allowable deductions on a business return. So yeah, it’s very important that when you have a business, you keep separate bank accounts from a personal standpoint and the business standpoint, both from the IRS’s perspective, and then from creditors perspective too, because that’s one of the primary factors in deciding whether or not that corporate veils pierced if the businesses ever sued. And it just doesn’t stop at bank accounts.
It means you got to keep separate records if you have multiple businesses. You know, we were talking earlier about protecting one business product line from another business product line. Well, that only works if business A keeps separate accounting records and business B keeps separate accounting records, and they both have their own checking accounts.
So it’s very important that you honor the separateness of a particular entity and not commingle it with other businesses that you have and with your personal assets as well.
Armando (49:23 – 49:33)
Yeah, and not having one QuickBooks file that just tracks everything. That might be convenient, but that might not be the best choice.
Richard (49:33 – 50:31)
Yeah. Yeah, that’s something to keep in mind. You know, a lot of our clients invest in real estate and they have multiple rental properties and a common question we get as well, should I have one LLC for each property?
Should I have, you know, one LLC for all properties? And, you know, when you are confronted with that situation, you got to keep that in mind. You know, if you do have one LLC for multiple properties, then all the equity in those properties are going to be at risk if there’s an issue with just one.
But as you add more properties and more LLCs, you got to maintain the separateness of each of those LLCs as, you know, much of an administrative burden that may place on you. If you don’t do that, you’re going to get in trouble if there’s ever an issue with one of those properties.
Armando (50:32 – 52:01)
Yeah, if there’s an issue, and I had a conversation yesterday with a property and insurance person. Property and cashfully is the general category for, say, your homeowner’s insurance. And so we were talking about just what you said, people have real estate, multiple, you know, maybe rental real estate, and they’ve got different, maybe a single family home as a rental, maybe a condo or something.
But what’s very, very common now is the short term rentals, Airbnb, VRBO, short term rentals, where some stranger is leasing your house for two nights, and then that stranger is gone. So some insurance companies will not insure those types of rentals, period. So somebody who has, say, half a dozen rentals, and each one is in or if they’re all in one LLC, but one of those is one of those short term rentals, and there’s a problem, then all the rentals get stuck in that problem.
And they could potentially lose the value of all those assets with with that. Yeah, yeah. So it just drills home that they really need to think about that separate LLC for each property to isolate the risk, especially if they have things like an Airbnb or a VRBO short term rental, where the liability is so much higher, because they’ve got so many tenants over that calendar year, coming and going very, very quickly.
Richard (52:01 – 52:19)
Yeah. And inherently, they’re much those tenants are much more what I know the term for it, but less likely to treat the property well, then, you know, probably, probably much more party oriented.
Armando (52:19 – 53:37)
That could very well be. So the next thing that on the agenda here is umbrella liability insurance. And what what I’ll often hear from a new client of ours is how much should I have?
So the insurance experts I’ve spoken with about this, their response always is, well, first, let’s look at the net worth of that family. Is the net worth 10 mil? Well, then let’s make sure they’re covered for 10 mil.
And but but that really needs to be the starting point of an umbrella policy, because the idea of the umbrella, sometimes it’s called an excess policy. But the idea of that is that if you are not insured, for personal things, and you think you are insured, but you’re not, this umbrella is kind of a catch all for that. So it’s really, really important that families that own a business understand what the umbrella is for, and that it is for personal things, not the business, it’s there to protect the family, the personal side of things, and making sure they have enough coverage there.
So if there is an incident that they’ve got a, as you said, a first layer of protection, should something happen?
Richard (53:38 – 54:00)
Yeah, that’s what we typically tell people to buy as much insurance as you can afford, as long as it’s reasonably priced. And I always tell people to talk to their insurance agent and to find a good one, because, you know, it could potentially save you a lot of money by having those types of policies in place.
Armando (54:00 – 55:04)
Yeah, exactly. And then let’s talk about business succession. Business succession is often neglected, people just don’t think about it.
Of course, when there’s an untimely death, then, you know, that’s just, it’s just reality, it just happens. But business succession, the way we’ll position that when we talk with the business owner about it is, we all die. We all die.
So either you plan for your exit from the business, or when you die, it will happen without you doing any planning at all. And which of those scenarios is better for your family, that you plan ahead, that they get some value from that company. And you plan it in advance, so that when the business owner’s time comes, it’s horrible that spouse lost the business owner and that kids lost the business owner.
But at least the wealth that was built up over years in that company, that that can be preserved for the benefit of the family as much as possible.
Richard (55:06 – 56:41)
Yeah, yeah, I’ve seen this happen a few times where the business owner did no planning. They were in a dispute with a family member who was basically no longer a part of the business, except for on the records only for several years. And these two people did not get along.
But the one who was divorced from the business came back after the business owner died, because no planning was done and basically was able to take the entire value of the business because the person who failed the plan didn’t remove her sufficiently to the extent that she no longer had an interest. So she was able to take the value of this business that this man had created for the last 15 to 20 years. And then to make matters worse, there were potential legal claims that she had against the widow of the other business owner.
So it’s very important to do that planning to prevent scenarios like that. And then also to just ensure that there’s a smooth transition, that value is maintained, and that that family is going to get as much out of that business as they possibly can, you know, without having to face substantial loss.
Armando (56:42 – 57:27)
Yeah. And this gets back to what we talked about earlier with business succession. If there are partners having a buy-sell agreement, you know, and funded with some inexpensive term life insurance, that’s one way that you can put something in place that will get value to the company.
And in that scenario for business succession with a buy-sell in place, it may be that the life insurance policy is ensuring the life of the person who died. And maybe the beneficiary is the company, but then the company now has the money to buy out the deceased person’s spouse or family. But that buy-sell can just become critical in that scenario.
Yeah.
Richard (57:28 – 58:00)
Yeah. You know, the buy-sell too can cover other things along with just death. So I mean, they can cover breaches of the operating agreement.
It can cover what if a business member is convicted of a felony? What if they become disabled? So these are all situations that a buy-sell agreement can protect both business owners from disaster and from their partner if something goes horribly wrong.
Armando (58:01 – 58:12)
Okay. Or if a partner does something really dumb or gets in the paper because it’s really dumb and it negatively impacts the business, that could be a buy-sell trigger as well. Yeah.
Richard (58:13 – 58:24)
Anything that you want to label as what we call a triggering event. And when a triggering event occurs, that triggers the buyout of a member.
Armando (58:25 – 59:21)
Okay. And in business succession as well, sometimes, and I had this conversation with the business owner yesterday, his intent is to transition the business to his adult daughter who is in the business and runs it. And I asked, are there any other adult children that you have who are part of the business?
His response was, no, my other daughter has her own thing going. She’s not part of the business. And that sounds great.
But from, you know, keeping things nice and neat and clean, certainly be best if that was all written out somewhere in some document, either the state documents or maybe the buy-sell agreement or something so that the daughter who is left out is aware of that ahead of time and they can have those family conversations ahead of time. And hopefully after dad passes away, it doesn’t become a fight between the sisters of whose company is this.
Richard (59:22 – 59:35)
Exactly. Yeah. If there’s nothing done and it’s not, you know, designated in a will or a trust that the business goes to the daughter who actively participates, then it’s going to be split between the two of them.
[Speaker 3] (59:36 – 59:36)
Yeah.
Richard (59:36 – 59:46)
And that defeats the purpose of the father’s wish is to have that business left to the one that is actively working on a family page.
Armando (59:46 – 1:00:08)
And sometimes though, as I’m having this conversation with a business owner, they might say, well, you know, what’s fair and what’s equitable? You know, they want to give each of the kids a pro rata portion. So in the example of two daughters, well, if the families were 20 mil, they want to leave 10 to one daughter and 10 to the other.
But often with the business, the business is the bulk of the wealth.
[Speaker 4] (1:00:09 – 1:00:09)
Yeah.
Armando (1:00:09 – 1:00:24)
The business doesn’t have millions of dollars in cash to equalize things. So that’s when maybe a life insurance policy can produce some cash that can help to balance out those scales when the business owner dies.
Richard (1:00:25 – 1:01:06)
Exactly. And, you know, maybe there’s other devices or techniques that can be used outside of that if the person is uninsurable, such as promissory notes and payments over time. Right.
The important thing is to, like you said, Armando, to start thinking through that succession plan to make sure that, you know, your wishes will be honored and carried out rather than having nothing down on paper at all and just hoping that, you know, what you want to have happen actually happens, which is far from usually likely in my experience.
Armando (1:01:07 – 1:01:11)
Right. Yeah. There are too many things that can go wrong and get in the way.
[Speaker 4] (1:01:11 – 1:01:11)
Yeah.
Armando (1:01:12 – 1:02:54)
Along the way. So let me just summarize just a little bit quickly here and we’ll begin to wrap this up. So we talked about the basic estate documents and, you know, keeping things simple, as simple as possible when, you know, when your time comes, of course, making sure that the people get what you want them to get in the estate documents.
That’s where they define that. Having the beneficiaries control the assets, saying a beneficiary trust so that it continues being protected from creditors once it passes from, say, mom and dad to the next generation. You talked about a will, the importance of having that will and talked about probate as well, how probate can be avoidable.
You talked about a trust, having a revocable trust and or an irrevocable trust and the pros and cons of that and why people need to think about those. Talked about powers of attorney as well for health care, power of attorney and durable power of attorney as well and why those matter. So people, I’d say Richard, don’t often really understand what those documents are and they don’t understand how powerful those are.
So I’m very grateful that we’re having this conversation so that people can learn a little bit from this and hopefully give you a call and ask any specific questions they might have. And then we talked about titling assets in the name of the trust so that when the person, you know, the assets go into the trust as has been written out already and they get dispersed, they get funneled through that the way that the people want them to, the way the deceased person wants them. Sound about right?
Richard (1:02:54 – 1:02:56)
Yeah, that’s a great summary.
Armando (1:02:57 – 1:05:24)
Okay. And then we talked about protecting the business specifically about, you know, having the right kind of entity, having an entity, first of all, some kind of an entity, an LLC or something, but having an entity there to help protect the business and protect the family. Talked about when you have a partner, have a partnership agreement, a buy-sell agreement, you know, why that matters.
You mentioned having an operating agreement in an LLC that that’s going to define a lot of things there as well. We talked about retaining key employees to help retain the value in that business when that business owner passes and talked about key person insurance, maybe deferred compensation, maybe a qualified plan or a pension plan or something else. We also talked about looking at that business and if there are separate business components that really can be separated, maybe they should be separated for asset protection purposes, like maybe a fleet of trucks or a fleet of equipment or something into a separate entity, then maybe that’s worth considering to help that family and protect the business.
And we talked about having the right types of just insurance on the business itself, making sure you’ve got a good person who understands your business and that they can help identify those risks and provide the insurance there that can help, as you said, be that first line of defense if something happens and comes along the way. And then the last part that we just talked about is separating things. We talked about not commingling assets.
If you have maybe pieces of real estate, maybe having a separate LLC for each one of them and then respecting that structure by having separate bank accounts for each of those property, a separate accounting, which, like you said, can be an admin burden and take a lot of time. But is it really worth it? And should they be aware?
Shouldn’t the owner be aware that why it’s important to at least think about it? If you choose not to do it, that’s one thing, but at least understand what you’re doing and know going in with your eyes open, but keeping assets separate that way. And then umbrella liability policy and the business succession.
So Richard, if someone has questions and wants to talk with you, what’s the best way for them to reach you? We’ve covered a lot of material, but we only really touched the surface of it. And there’s a lot more that we could have talked about.
How would you prefer people get in touch with you?
Richard (1:05:25 – 1:05:37)
Yeah, the best way to reach me is through phone. So my direct line here at work is 480-664-7472. That’s 480-664-7472.
Armando (1:05:38 – 1:06:35)
Okay, perfect. Perfect. Great.
And then, you know, from our perspective as the wealth manager, as the multifamily office here, we’re helping that family protect their overall net worth, help them manage the money. And once they go through that business succession, helping them maintain that lifestyle that they’ve enjoyed while they’ve owned the business, beyond the business and helping them just pass assets to next generation, meet those charitable goals that they want to reach and all that. So from a wealth management perspective, that’s always our lens.
And that’s why I appreciate the work that you do, Richard, because you’re helping build in many of those protections and lightening up, taking a burden off their shoulders, when they actually, when their time comes and they pass, it’s easier on the next generation and on the continuity of that business for the benefit of the family.
Richard (1:06:36 – 1:06:55)
Exactly. Yeah, it’s very important to do this planning. And like I always say, the people that typically get spurred to come in and see us are people that just went through a bad situation themselves.
And now they don’t want their family have to relive what they just suffered through.
Armando (1:06:56 – 1:07:17)
Yeah, yeah. Well, I’m glad that you’re there to help navigate that more often ahead of time than after the fact. And again, your phone number, he said 480-664-7472.
If anyone has questions for me, my phone here is 480-367-9000. Richard, thank you so much for the conversation. Really enjoyed it.
We’ll have to do this again.
Richard (1:07:17 – 1:07:22)
Yeah, thank you, Armando. Thanks for the time and allowing me to talk about this stuff with you.
Armando (1:07:23 – 1:07:51)
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