Benefits of Special Purpose Entities for Businesses
When buying a business in Florida, the use of a Special Purpose Entity (SPE) can help you leverage your buying power. A business buyer may need to only come up with 5-10% of the purchase price of the business. In addition to this, an SPE has several benefits for business owners.
Special Purpose Entity Provides Asset Protection
The core of any successful business is its ongoing operations including its manufacturing of goods or provision of services to its customers, its financial dealings with lenders and suppliers and its marketing to prospective customers. The biggest potential for legal liability suits that a business encounters is typically associated with its core business. Lawsuits are most likely to arise out of financial transactions or from business interaction with third parties such as customers, clients or suppliers.
Loss of Core Business Assets
A successful business owner can find new customers and can change suppliers and finance companies but, a business cannot easily replace its most valuable assets. A business that has its most important assets taken by a judgment creditor will not survive. For instance, a business will have difficulty overcoming a judgment which levies upon assets essential to its core business such as its real estate used for offices, storage, or production, its receivables or the equipment and intellectual property the business uses to produce services or products. Core business assets are essential to the survival of small businesses.
Core business assets are vulnerable if they are owned and operated by the same legal entity because a judgment against that business entity will threaten the core assets and thereby jeopardize business operations. Business asset protection starts by separating the ownership of core business assets from core business operations which are susceptible to lawsuits. A core operating business can use essential core assets even if the legal titles to the same assets are owned in the name of a different legal entity such as a different LLC or corporation.
Purpose of SPE
The entities which own business assets are often referred to as “special purpose entities.” Their special purpose is to own, hold and maintain assets that are essential to an operating business. A special purpose entity can have legal title to real estate, intellectual property, equipment or even accounts receivable. The SPE may lease or license its assets to the core business, and the core business pays the SPE for asset use in periodic payments of rent or license fees at market value. These lease or license payments are tax deductible by the core business entity and are income to the SPE. A judgment against the core operating business should not endanger the assets owned by these special purpose entities.
The Business Plan
To be effective, a business plan needs to separate business assets from core business early in its business history and prior to any threat of litigation. A business’s assignment of its assets to a separate entity can be attacked as a fraudulent transfer if it appears that the business planning was undertaken primarily to place the business assets outside the reach of creditors. Also, Transfers of assets from a core business to an SPE after a business has grown may accelerate taxation of income. The transfer of an asset to an SPE will be treated as a sale of the asset for tax purposes. If the business has depreciated the asset, or if the asset has appreciated in value (such as land) then the transfer to an SPE may accelerate taxation of the amount by which the asset’s value at time of transfer exceeds its adjusted tax basis.
Assets Special Purpose Entities Should Own
Many small business owners also own commercial real estate which the business uses as offices or warehouses. A judgment against the business will immediately and automatically become a lien on business real estate. A business should set up an SPE such as an LLC or partnership to take legal title to business real estate at the time of purchase. The business then will lease the building from the SPE, and the SPE will flow through to the individual business owners depreciation and other tax losses associated with the real estate.
Small business owners often underestimate the value of their intellectual property including trademarks, copyrights and patents. A business’s intellectual property may have little value to a third party or creditor, but the same intellectual property is essential to the debtor’s business. The debtor’s business could be forced to shut down if an unfriendly judgment creditor levied upon essential patents, trademarks or other intangible property.
A business asset protection plan should title all intellectual property in a SPE and have the SPE license the use of the property to the core business. There should be a written licensing agreement and monthly payments close to fair value. The license agreement must contain customized asset protection provisions. If a creditor obtains a judgment against the core business the owners probably can reorganize their business and enter into a new licensing agreement with the SPE.
Business owners tend to warehouse large amounts of cash in business checking accounts. A judgment creditor will move quickly to garnish all business financial accounts. Bank garnishments are the easiest and fasted way for a creditor to execute a money judgment. A business concerned about a potential lawsuit should keep just enough cash on hand to pay immediate obligations such as employee salaries and vendor payments. Surplus cash can be distributed to the business owners in the normal course of business. It is important to demonstrate a history of distributed profits to owners because there will be fraudulent transfer issues if a business makes a one time distribution to owners of a large amount of accumulated business cash in the face of litigation.
Alternatively, if a business needs to retain cash surplus the business should not hold the cash at the same bank where it maintains its operating accounts. A judgment creditor will usually know the debtor business’s primary bank from which the business writes most checks, and the creditor will quickly garnish all accounts at that bank. Creditors will not immediately know about business accounts at different banks, or even in different states, that hold business cash not used for deposit or checking in the normal course of business. However, a judgment creditor will eventually discovery all cash accounts through post-judgment discovery. Additionally, there are some banks that are very difficult to garnish under applicable law even if the creditor knows of accounts at such banks.