Rich Dad Advisor's Series

1. Choose the right entity to protect your assets and limit liability

"For as important as knowing which entity to use for running your business, protecting your assets, and limiting your liability is knowing which entity NOT to use."

Avoid risky entities. Sole proprietorships and general partnerships provide no asset protection and expose owners to unlimited personal liability. Instead, consider corporations, limited liability companies (LLCs), or limited partnerships (LPs) to shield personal assets.

One size doesn't fit all. The best entity depends on your specific business goals, tax situation, and risk profile. Factors to consider include:

• Number of owners
• Management structure
• Tax treatment preferences
• Asset protection needs
• Fundraising plans
• Industry-specific regulations

Consult professionals. Work with an experienced attorney and accountant to select and set up the most appropriate entity for your situation. The upfront cost is worth the long-term protection and benefits.

2. C Corporations offer maximum tax advantages and fringe benefits

"As we have learned, one entity size does not fit all business scenarios. There are situations when an LLC is called for and times when an LP is the best vehicle. But in terms of maximizing deductions and taking advantage of the tax laws for fringe and other benefits, nothing beats a C corporation."

Maximize deductions. C corporations can deduct a wider range of business expenses than other entities, including:

• Health insurance premiums
• Life and disability insurance
• Retirement plan contributions
• Travel expenses
• Entertainment costs

Lower tax rates. C corporations pay a flat 21% tax rate on profits, which can be lower than individual rates. This allows for accumulation of earnings at a lower tax cost.

Fringe benefits. Owners who are also employees can receive tax-free fringe benefits like health insurance, disability insurance, and death benefits. This is not possible with S corporations or other flow-through entities.

3. S Corporations provide flow-through taxation but have strict rules

"As discussed, for certain businesses an S corporation is the right choice. You just need to be careful not to lose your tax status through inadvertence or a less than complete understanding of the rules."

Flow-through taxation. S corporation profits and losses flow through to shareholders' personal tax returns, avoiding double taxation. This can be advantageous for businesses that want to distribute all profits to owners.

Strict eligibility requirements. S corporations face limitations:

• Maximum of 100 shareholders
• Only U.S. citizens/residents as shareholders
• Only one class of stock allowed
• Certain types of businesses ineligible

Easily terminated. S corporation status can be inadvertently lost by violating any of the eligibility rules, such as transferring shares to an ineligible shareholder. This results in immediate C corporation taxation.

4. LLCs and LPs offer flexibility and charging order protection

"The charging order procedure is a unique part of the asset protection offered by limited partnerships and limited liability companies."

Management flexibility. LLCs and LPs allow for customized management structures. LLCs can be member-managed or manager-managed. LPs have general partners who manage and limited partners who invest passively.

Favorable tax treatment. By default, LLCs and LPs are taxed as partnerships with profits/losses flowing through to owners. LLCs can also elect S or C corporation taxation.

Charging order protection. If an LLC/LP owner is sued personally, the creditor's remedy is limited to a charging order. This gives the creditor only the right to receive distributions, not seize the ownership interest or assets. Key benefits:

• Preserves business continuity
• Deters frivolous lawsuits
• Creates "phantom income" tax liability for creditors

5. Nevada corporations provide superior asset protection and privacy

"Nevada protects the privacy of individuals. The state is the only one in the U.S. that does not share information on a corporation's shareholders with the IRS."

Enhanced privacy. Nevada does not require disclosure of shareholder information and allows the use of nominee officers/directors to keep owner names off public records.

Strong asset protection. Nevada law offers:

• No personal liability for corporate debts
• No franchise tax
• No state corporate income tax
• Protection from charging orders
• Directors/officers can be indemnified against lawsuits

Multiple entity strategies. Using Nevada holding companies in conjunction with operating entities in other states can provide tax savings and enhanced asset protection.

6. Follow corporate formalities to maintain liability protection

"Failure to follow such formalities may allow a creditor to disregard the corporate veil and seek personal liability against the corporate officers, directors, and shareholders."

Maintain separateness. Treat the corporation as a separate legal entity:

• Hold regular meetings and keep minutes
• Maintain separate bank accounts and financial records
• Use corporate name on all documents
• File separate tax returns

Document major decisions. Keep written records of important corporate actions like:

• Issuing stock
• Declaring dividends
• Approving major contracts
• Electing directors/officers

Annual requirements. File required annual reports and fees with the state. Hold annual shareholder and director meetings, even if just to ratify actions taken during the year.

7. Use buy-sell agreements to control ownership transfers

"A buy-sell agreement is used by the owners of a small closely held business entity to cover the buyout of shares upon death, divorce, disability, or withdrawal of an owner."

Trigger events. Specify situations that activate the agreement:

• Death of an owner
• Disability
• Retirement
• Divorce
• Bankruptcy
• Desire to sell shares

Valuation methods. Define how the business will be valued:

• Fixed price (updated regularly)
• Formula based on earnings/assets
• Independent appraisal

Funding. Consider how a buyout will be funded:

• Life insurance policies
• Installment payments
• Sinking fund
• Bank loans

Restrictions. Include provisions to maintain control:

• Right of first refusal on share transfers
• Forced buyouts of departing owners
• Limits on transfers to non-family members

8. Carefully structure your management team and employee agreements

"To fully maximize your C corporation and the available deductions it offers, consider adding a good accountant to your team."

Build an advisory team. Surround yourself with experienced professionals:

• Attorney
• Accountant
• Financial advisor
• Insurance agent
• Mentor/coach

Employment agreements. Use written contracts to clarify:

• Job duties and expectations
• Compensation and benefits
• Confidentiality and non-compete clauses
• Termination conditions
• Dispute resolution procedures

Equity incentives. Consider offering stock options or restricted stock to attract and retain key employees. Structure vesting schedules to incentivize long-term commitment.

9. Understand securities laws when raising capital for your business

"Raising money for your business can be tricky. In fact, if you do it the wrong way you can land in jail."

Private placement exemptions. Most small businesses rely on private offering exemptions to avoid costly SEC registration:

• Rule 506(b) - No general solicitation, up to 35 non-accredited investors
• Rule 506(c) - General solicitation allowed, all accredited investors
• Regulation A+ - Mini-IPO for up to $50 million

Disclosure requirements. Provide potential investors with material information:

• Business plan and financials
• Risk factors
• Use of proceeds
• Management team background

State regulations. Comply with state "blue sky" laws in addition to federal rules. Some states require merit review of offerings.

10. Plan ahead for potential dissolution or sale of your business

"As mentioned, the directors (or trustees in some states) charged with winding up the affairs of a dissolved corporation can be held personally liable for a failure to pay creditors."

Dissolution procedures. Follow proper steps to wind down:

• File dissolution papers with the state
• Notify creditors and settle debts
• Distribute remaining assets to shareholders
• File final tax returns

Asset protection. Consider keeping the entity alive for several years after ceasing operations to maintain liability protection against potential claims.

Exit strategies. Plan ahead for potential exits:

• Sell to a third party
• Employee stock ownership plan (ESOP)
• Management buyout
• Initial public offering (IPO)
• Liquidation

Succession planning. For family businesses, create a plan to transfer ownership and management to the next generation or professional managers.

Last updated: October 12, 2024