Estate planning for small business owners:
Those personal guarantees may mean you risk it all
By Laura A. Bruce • Bankrate.com

The money pit. It's a pretty good definition of most small businesses that are getting a start in life. Whether it's a trendy new restaurant or a mom-and-pop grocery store, new businesses gobble up money the way a growing child wolfs down food.

In their struggle to make the businesses survive and thrive, owners often pump a lot of their assets into the company. Some max out personal lines of credit, take out second mortgages on their homes or personally guarantee business loans using other major assets as collateral. The risk is, if the business fails or if the owner dies, assets can be wiped out.

"If a person has a small business and they have loans with personal guarantees, they need to think, 'What will happen if I die with all this debt?' When a business owner is too extended, they're risking that their heirs will be left without anything and maybe have additional debts to deal with," says John Ventura, a Brownsville, Texas, lawyer and author of The Small Business Survival Kit. In short, they could become bankrupt.

Know the law
Ventura says creditors can go after the assets of the business and personal assets of the owner that aren't exempted by federal or state laws.

Bankruptcy exemption laws vary from state to state. (Most states list them on their Internet sites.) But don't count on them to save your estate from creditors, says Ventura. "California, Florida and Texas have extremely generous exemption laws, but in other states the home equity may be just a few thousand dollars; some states barely let you keep more than a Bible."

One way to keep creditors from having access to personal assets is to incorporate, says CPA David Bendix of the Bendix Financial Group in Uniondale, N.Y. "It's good for liability purposes, but you still have to remember not to co-sign personally for loans."

Avoid guarantees
Ventura says the incorporated business owner should be prepared for banks to apply a lot of pressure for the owner to sign a personal guarantee -- but don't assume it has to be that way.

"If your business has enough assets, accounts receivables, inventory, physical equipment, then you may qualify for no personal guarantee -- that's your argument," he says. "Make the effort to prove that you're fully secured to avoid personal guarantees."

If there's no way to avoid signing personally, then consider buying an insurance policy or sheltering assets through redistribution.

Insuring for survival
With or without incorporation, an insurance policy is a popular form of protection for many business owners who don't want to lose their personal holdings.

"That's a significant sales area for us," says Ted Kirchner, marketing director at The Prudential Insurance Company of America in Newark, N.J. "We sell a lot of insurance to business owners who want to prevent that from happening."

Kirchner says most owners will buy term insurance to insure a loan. "It's spread out over the length of the loan -- it's the cheapest way to cover."

In fact, insurance is often required by the financial institution making the loan, says Kirchner. "Sometimes the banks or lenders have their own credit insurance that they demand be purchased by the owner."

But purchasing a personal policy can be a wise move even if the lender doesn't require insurance.

"You'd want it especially if you're using your house or other personal assets as collateral," says David Bendix. "Also in case of disability -- a disability policy can pay back loans or any kind of indebtedness."

Shifting ownership
Prudential's Kirchner suggests another, but sometimes risky, way to protect assets -- remove them from the business owner's name. "Re-titling property in other family members' names or gifting between spouses can shelter assets."

But there are drawbacks. Kirchner says transferring assets can be a bad idea if the marriage or relationship isn't secure. If there's a divorce or a disagreement, the business owner could lose assets. "Also, when business owners try to represent that they don't have any additional property to put on the table, then the lender has an opportunity to say no to the loan," says Kirchner.

Attorney Ventura says poor timing when transferring assets can cause serious legal problems.

"If you're going into business and there are no problems on the horizon and you don't have a lot of assets, it may be prudent," he says. "But if you're up to your eyeballs in debt and you're afraid you're not going to be able to pay them, you may be breaking fraudulent transfer rules."

Ventura says every state has fraudulent transfer rules and, in general, they state that a person can't transfer property out of their name with the intent of hindering a creditor or denying a creditor access to an asset. It varies from state to state as to how far back creditors can look for asset transfers.

"In Texas, any transfers less than two years before the time a creditor raises the issue may be examined," Ventura says.

Coming Monday: Borrowing for nonprofit organizations

There is a distinct subjective element in making loans to nonprofit groups, but lenders explain how churches and social service organizations are likely to be judged when they want to borrow money.

-- Posted: March 25, 1999