If a borrower owns its real estate, possesses significant fixed assets or operates several lines of business, your bank might be exposed to unnecessary risk. That’s why it’s important to review your loan portfolio for borrowers with certain traits.
Real estate and Fixed Assets
Commercial property ownership is risky, especially for retailers who invite shoppers onto their premises. Beyond the obvious risks, such as accidents, property owners have been held liable for crimes committed on their premises, including theft, rape and even murder, if a victim proves there’s inadequate security.
Liability insurance can mitigate losses due to such occurrences. But some policies are based on outdated business appraisals, and damages could exceed the borrower’s coverage.
For added protection, borrowers can create a separate legal entity for real estate ventures. Then they may lease the property to the operating business at fair market value. The same holds true for companies with significant fixed assets.
Such actions can help protect the operating business entity from property liability claims. The real estate venture could still be pledged as collateral for loans to the operating entity.
Multiple Business Lines
Suppose a pet supply retailer diversifies and explores the health food market. If the experiment flops, it might drag down the pet supply store (or vice versa). By setting up a separate legal entity for each business segment, a borrower limits its “spillover liability.” Keeping things separate from the get-go — with separate balance sheets and bank accounts — also is helpful if the owners subsequently decide to sell or seek additional financing.
Estate Planning Needs
Family businesses that want to transfer wealth to subsequent generations also may benefit from establishing separate legal entities — for example, an operating business that carves out its real estate into a trust or LLC. Active participants in the operating business are gifted interests in the business. And passive heirs are given pieces of the real estate venture.
Beyond limiting liability, “gifting” serves several goals. First, parents can use the annual gift tax exclusion ($14,000 in 2013) and the lifetime unified credit ($5.25 million in 2013) to gradually reduce their taxable estate. Gifts are usually discounted for lack of control and marketability.
Second, those active in the business get a stake in something they can directly impact: the value of the operating business. Passive investors are given access to a steady income stream. And the family can minimize its overall tax liability if children are in a lower tax bracket. It’s the best of all worlds.