Two recent conversations have reminded me of the importance of separating business enterprises for liability protection. I was helping a Sunnyvale real estate investor negotiate a commercial loan extension with a bank, and was thrilled that we had planned well in the past to separate all of his major properties into separate LLCs. It gave the bank a lot less power in negotiating against us – my client’s other properties were safe from this potential liability, but could be used as additional collateral if he chose to do so. At the same time, I was talking to a Mountain View manufacturing client about the risk of a potential employee lawsuit and realized that, due to some bad advice in the past that my client got from another advisor, he was holding real estate in the corporation thereby making the real estate subject to any liabilities of the company.
The example I often use is that each of your business enterprises or major assets is like a domino. Putting all of your dominoes in one entity means that a single domino falling can knock the others down too. Separating your dominoes into multiple entities means that if one entity is subjected to a lawsuit, the assets in the other entities should be insulated. Therefore, if my Mountain View client is faced with a large judgment on his employee problem, thanks to the appreciation in the real estate, the company looks like a really deep pocket.
Deciding how many entities to form, and how to separate your assets, is a complex cost/benefit analysis that depends highly on your level of comfort with risk. A good rule of thumb is to separate unrelated businesses (such as manufacturing and real estate, operating companies and investments). For real estate, consider grouping properties by the level of liability and the equity in each property, as well as the location of the properties. Also check with your professional advisors, such as your attorney and CPA, for liability, tax and insurance issues that could affect your decision.