No one has a crystal ball that that predict if or exactly when a recession is upon us. What 20 years of legal practice devoted to protecting billions of dollars in wealth for the most successful people in America has shown me, however, are some common key lessons:
- The only time you can prepare an effective legal and financial defense strategy is before trouble comes.
- No amount of wealth is infinite or makes you immune to systemic changes in the economy. We’ve seen even 8 and 9 figure net worth individuals lose a lifetime of success when “impossible” circumstances occurred.
- There are certain behavior and fact patterns that have been proven to predictably help successful people survive and even prosper in a recession, proven most recently by both the 2008 ‘great recession’ and the economic downturn that predictably followed the COVID crisis.
- The threats to your wealth increase in tough times and often include expensive litigation on issues including investor lawsuits, intracompany litigation, employee lawsuits and even personal injury claims, fraud and embezzlement. Be a hard target against all your potential risks.
Those who have weathered previous economic storms most effectively and with a minimum amount of trauma share the following characteristics.
- They and their advisors were aware of all their potential exposures and were proactive in addressing them.
- They were able to make their personal, family overhead commitments from existing resources for an extended period of time, even without additional cash flow.
- They were willing and able to adjust their personal and business overhead, lifestyles and expenditures to current economic conditions.
- They lived very well, but well within their means, as opposed to at the limits of their means.
- They had assets that allowed them to meet existing business financing burdens and other fixed costs in a form that they were able to liquidate at minimal delay and expense.
- They had great credit and personal relationships with banks and bankers that really knew them and their business and that allowed them to agree on terms that were best for all parties involved and, in some cases, had these relationships with several institutions.
- They had long term assets that were able to be made liquid with minimal penalty and delay, despite that liquidation not being part of the original plan, i.e. long term investments with an escape or liquidity plan built in.
- They had top counsel in place on tax, business and estate issues, and that counsel used a variety of strategies that not only served the primary goals but also protected key legacy assets for their family.
How To Crash Test Your Asset Protection Planning: What Happens If You Face a Threat?
- Do you have a personal liability umbrella insurance policy of at least $2 million?
- Do you have significant savings and investments that are exposed in your own name, rather than though a legal entity that is legally distinct from your personal and professional liability?
- Do you have one or more personal residences with significant exposed equity held in your name or in the name of your Revocable Trust? (AZ law protects only $250K of your home equity, in a single primary residence).
- Are your assets adequately protected from a professional or personal liability exposure that is either uncovered by insurance or that might produce a verdict/liability significantly above your insurance limits?
- Are you financially prepared for an event that would not allow you to practice your current profession any longer?
- If you own your own business, how long would your business be able to pay all its fixed expenses (like rent, salaries, insurance, etc.) without you personally producing income or going into personal savings?
- Do you have an employee or partner that produces an amount of income that is vital to the operation and solvency of your business (key person)? If yes, are you adequately prepared and insured for the loss or disability of that individual?
- Is there a latent risk in your life you are aware of and have been avoiding addressing for any reason, such as a family member, partner, or employee with a behavioral or compliance issue or even some physical safety issue at your business or on your property? It’s amazing how many times a client tells me after a crisis, “I was always worried that this would happen…”.
We can help you address many of these areas if you need help.
Invest Some Time and Money in Yourself
Make sure you are keeping on top of little health issues that can escalate into big issues, and stay insurable, stress kills. Make sure your family estate planning is complete, up to date and reflects the guardians and trustees who you still trust the most. If you have old planning, update it. Not sure? We can have an expert review your Revocable Living Trust (as one example) for as little as $500.00 and spot issues that could cost millions if not addressed.
How To Crisis Test Your Estate Planning: What Happens If You’re Not Here?
- Do you actually have an estate plan?
- If yes, does your family know about it, is it up-to-date, and are you comfortable with your instructions and the people you left in charge as guardians and trustees?
- Will the assets you leave behind be adequately protected for your heirs from both your and their known and unknown creditors?
- Has your spouse been adequately included in your relationship with your legal, tax, and investment advisors and are those relationships good enough to provide the guidance your family will need?
- Do your children have adequate financial discipline and education to handle and best use what you are leaving behind for them?
- If not, or if they are minors, are your comfortable with the skill and commitment of the guardians and advisors that your estate plan names?
- Is the amount of wealth your family would be left with tomorrow adequate to provide the income and stability for them to have and do everything you are working to provide?
If you don’t like your answers to these questions, we can help. Have good planning? Great – please make sure it is actually funded with the assets you created it to protect and convey and make sure your family knows where it is and who to turn to for help. We often see that the family is only vaguely aware that “mom and dad have a will or trust”, but they don’t know who did it or where it is. These issues are easily addressed but become a nightmare in a time of crisis.
Use Caution with Real Estate Deals and Personal Guarantees
Try to avoid or carefully limit personal guarantees. If you must sign a personal guaranty, try to limit it to a specific amount or percentage such as your actual percentage of ownership rather than “jointly and severally” guaranteeing an entire deal that you only own 25% of. If there is more than one guarantor, consider a contribution agreement among the guarantors to establish, as among themselves, the proportionate obligation of each partner. The per-capita (per head) allocation otherwise generally used by courts may be very far off from the actual ownership share of each guarantor in the business. Creditors will usually and most aggressively chase the deepest pocket, which may be yours, in the event of a default. Lawyers don’t waste time chasing people who are already “broke”.
Business Owners: No business is completely recession proof. Diversify and properly insulate your income streams if possible and be ready to be flexible and spot ways to identify new opportunities for your business and your skill set.
- Realize that your current business niche, as you have defined it, may slow down or come to an end and know when to direct your assets and energy to new opportunities. As examples, some of our clients who were major players in single family housing are now in the apartment market segment and are doing well. Doctors expanded their practices and added high value cash services like medically supervised weight loss to practices that were focused solely in other areas. Others have created booming new businesses like PPE supply chains, or debt and credit repair that directly reflected the current economy.
- Don’t take your market position for granted. In a down economy discount solution, product and service providers emerge in every market. These competitors will be selling price first and many consumers won’t see the differences until they have been poorly served and you have lost the business. Some steps to fight this:
– Make sure that your network and professional relationships are as strong and developed now as they were before you reached your current level of success.
– Look for ways to distinguish yourself and your business and maintain the highest standards of professionalism and service.
– Look for every way to add value and collaborate with other top services providers you work with so that you are a natural and logical part of every project or client they are involved with.
– Become part of a best of class team of teams that delivers the highest value to the consumer. This is true of everything from medical services to commercial contracting.
– Continue to be the best, or at least great at what you do. “Good enough” should not be part of your vocabulary.
Guard your credit like gold.
Good credit and access to capital is always important on both personal and business fronts, but it is indispensable during a recession. Check your business and personal credit reports now, before you need credit, and see if they are accurate. There are services out there that can help remove negative or inaccurate items in a short period of time, potentially increasing your credit score by dozens of points.
As credit markets tighten even the wealthy have trouble obtaining credit for everyday issues like business financing and home and auto purchases. Banks have historically pulled in the reigns on lending to all but those who have sterling credit, “good” will no no longer good enough. Late payments of any kind may move you to the default interest rates permissible under various types on loan and consumer credit agreements to generate fees and increase revenue internally. On a personal level, this could mean that your VISA at 12% jumps to 29.99% APR if your spouse sends in the check late.
On a business level, it is much worse. If your course of business has been to pay certain credit lines down late to a friendly creditor, it could now put you into default or cause an acceleration.
We are also saw that clients who predictably used revolving credit lines for years as part of their business model either for capitalization or to pay recurring expenses suddenly found that their credit lines were terminated or drastically reduced as is permissible in the fine print of most such agreements. This was even though many clients had no change in their income or credit. Banks simply decided that they had too much loan and credit exposure and proactively limited existing borrowers’ ability to draw that money out.
If you have a credit line that you know you are going to need or cannot risk losing, consider drawing the money out now and look at the interest cost like an insurance premium. You may not want to pay it but if you need the “insurance” of having that money available, it might not be available at any reasonable cost, certainly not in any short-term scenario.
We also saw banks that were in financial trouble and which needed to reduce their outstanding debt balances engage in strategies like re-appraising property they financed over 18 months ago to “current market value” at ridiculously low valuations then going back to the borrower saying they immediately need more collateral (collateral shortfall) or they will call they note as the “fine print” legally entitled them to do. How bad can this be? In one case the bank re-appraised one of my client’s multi-million-dollar commercial properties at about 50% of its current fair market value and wanted an additional seven figures in collateral. Fortunately, this client had sterling credit and good professional relationships that allowed him to re-finance at a lower rate with a more solvent and ethical bank.
Invest In Your Business Legal Planning
Now is the time to do some fine tuning. Make sure your liability insurance coverage is adequately in place and at the right limits to cover all predictable exposures beyond your core business liability including employee lawsuits, data breaches and acts of violence on your premises.
It’s also vital that you locate and update your core business documents including corporate documents, contracts, employment and loan agreements and buy sell agreements, among others. Many business owners don’t know that a vital document is missing or never actually existed until they need it when a crisis occurs.
Are your Buy-Sell Agreements Actually Funded?
If you have partners in your business or medical practice, do you have a buy-sell agreement that is all of the following:
- Up to date in its valuation of your business
- Adequately funded with all the appropriate life, disability, and other insurance required to cover every partner’s family
- Professionally drafted to cover the “Five-D’s”: death, disability, disqualification, departure, or divorce of any partner
We also see that many of our clients who have buy-sell agreements in place either don’t have adequate insurance coverage and current appraisals or in the worst cases, the life and disability insurance required has never actually been purchased. With life insurance, this leads to avoidable expense, delay and in many cases litigation when one partner dies, departs, gets divorced etc. and the surviving spouse and heirs are suddenly trying to get a business appraised and fighting for what is theirs. This can lead to the untimely sale and liquidation of the business or its assets and really create a mess for the surviving partners during already trying times.
Similarly, think of where scenario where the business is supposed to have a disability policy in place on various operating partners but never gets it. Then one of the partners has a disability event like an injury or illness and can’t work but needs income. This is a big hit to the business, not only is it down one productive person, but the other partners have to continue to pay the disabled partner. This leads to resentment, financial burden, lawsuits and other issues that again could be simply and cost effectively avoided if timely addressed.
It’s important that your agreements and appraisals are up to date. Even in cases where the agreement is in place and has actually been funded as specified, we often see cases where it was done so when the business was young, and worth less (or more). Now, 10 or more years later, the business has much higher or different revenues and actual value, and the “old” appraisal, agreements and insurance coverage limits are no longer valid or adequate to compensate the owners as expected. What’s worse, not having enough insurance to pay off a partner’s family as you agreed to, or being legally obligated to pay them $10MM for shares of a business that are actually now only worth $5MM? Both are terrible outcomes that can be avoided with good planning.
Exit Planning Done Right Is More Than Just the Sale Transaction
If you are at a point where you are ready to exit a business, top notch legal counsel on the transaction itself is always vital and perhaps the most obvious counsel you need. A carefully drafted and enforceable sales agreement is only part of what you need however, and it’s important that your planning helps you make it, keep it and pass it on.
Many succession and exit planners focus only on the deal terms, taxation, the valuation, estate planning, life insurance sales and where your sales proceeds will be invested; these are all good questions. But what they routinely leave out is any real plan to protect this additional wealth while you are alive.
Asset protection, perhaps counter intuitively, is just as important for entrepreneurs who are selling their businesses as it is for those who are running one. In fact, “selling a business” is one of the “asset protection risk factors” we discuss with every client.
The first and most obvious example of this failure is not being adequately insured for traditional malpractice, E&O or D&O coverage (as appropriate) after you sell or retire. This takes the form of “tail” insurance at or above the same level of coverage they carried while running the business. This is important for several reasons; the obvious one is the liability of a claim itself, the second is that the damage the claim can do to you and how aggressively it will be pursued is actually magnified when you are no longer in business. The costs of defense alone can put many sellers at a disadvantage or back them into a corner where they have to settle a claim they shouldn’t have.
Cash-rich sellers are often more vulnerable to any litigation or liability than ever before because:
-They are more liquid than ever before.
– They have replaced a recurring income stream with a single lump sum that has to last them “forever”.
– The fact that they sold their business and in many cases, the dollar amount they received are usually a poorly kept secret, this often motivates “latent plaintiffs” including disgruntled employees and current and even former partners.
– Most fail to contractually assign any payment stream to a protected entity, so that it is protected from their personal and professional liability.
Business owners must remember that in many cases they will no longer have the income stream they previously did from their business to offset any claim-related losses and that they are a much better target (more collectible) than ever before. Why? Because even people with high incomes have usually not received a lump sum of cash as large as what they get from the sale of a business.
I also warn every client who is selling a business that asset protection planning is vital at the time of sale to protect the proceeds from the buyers themselves. I remind clients that if the buyer is not as successful at running the business as the seller was, for any reason (including the economy/recession their own lack of industry knowledge or business and management skills), they and their lawyers will inevitably point to some alleged act or omission on the seller’s part and will want to give the seller back the broken pieces of their business and get a refund. In many cases they want this refund only after they have destroyed the businesses’ credit, inventory, reputation and relationships that in most cases took decades to develop.
Making sure that the proceeds of sale are well protected from such an exposure with insurance, the right legal structures and the right contractual protections that limit their claims and remedies on the front end is vital to ensure your continued solvency and success. Call us now to schedule a consultation with Ike Devji.