Here are a few risk management tips to consider when forming new business entities.
Often business owners choose to form new entities because they believe it will reduce their overall liability, save on insurance costs, a portion of their current operations is very difficult to insure, or perhaps because they wish to expand their operations to include a product or service they previously did not offer.
One prevailing thought is, “If I form new entity A, it means my other entities will not be exposed to the liability of entity A.”
That’s true, and also false.
When I talk with attorneys, it seems fairly consistent that ownership of an entity does not create a liability exposure for the owner.
It stands to reason then that if a business owner owns 100% of multiple entities that common ownership generally cannot be used as a means to put one of the business owner’s entity’s assets at risk of loss due to the operations of another entity.
It would also mean if one entity creates a subsidiary, the parent company is generally not liable for the actions of its subsidiary. (Though I’m confident there are exceptions to this.)
When done correctly, forming a new entity is a great way to keep particular business liabilities separated and reduce overall risk of loss.
It may even be a great way to save on expenses too, but there is no business decision that comes without any risk at all.
Here’s a real-life example of where creating new entities begins to break down quickly:
A contractor builds both commercial and residential projects.
The contractor’s commercial insurer despises residential work, and refuses to insure them for such.
The contractor gets the brilliant idea to form a new entity to handle residential work and insures that entity separately from the commercial contracting entity.
Sure, all the work performed is done under a contract with the residential entity, but all the workers are employed by the commercial contracting business, all the equipment used is owned by the commercial contracting business, and all the prefabrication is done in and upon the commercial contracting business’s property and facilities.
Any claim can (and will) be easily tied back to the commercial contracting entity, and all the time and money spent to create the residential entity is essentially wasted.
Cue the clever legal language and maneuvering.
Here’s the thing about that: there is only one person on earth who gets to claim the title of being the shrewdest of all.
Odds are, that person does not actually know they are the shrewdest of all and the odds are even greater that person is not you, me, your attorney, or any other advisor.
My point? If you can come up with it, someone else can come up with a way around it so be humble and be careful.
Another consideration is the workers compensation experience modifier.
For those who may not know, that is a number to which your workers compensation insurer multiplies its rate to calculate your premium and is based upon claims experience.
For example: a 1.0 mod means you pay the rate just as it is. a 1.5 mod means you’re going to pay a 50% increase, and a .75 mod means you get a 25% break on the rate.
If there is 50% or greater common ownership between any entities (at least in the state of Florida), every entity in that grouping will share the worst workers compensation experience modifier.
That could create MASSIVE extra expense that a business owner is not anticipating when creating a new entity or even acquiring an existing entity.
One business is humming along nicely with a .80 mod rate and low workers comp premiums, and suddenly they have a 1.6 mod rate out of nowhere and their premiums are instantly doubled.
To finish, be wise. Carefully consider all the various angles of whether it truly is the best idea to form a new entity, and if you choose to do so be certain you’ve done it the best possible way.
I would advise you to list all the ways you can think of that it could go awry and address each one individually to ensure it has been accounted for as completely as possible.
While there is no foolproof method, doing so should allow you to enjoy the reduced liability and reduced cost you set out to accomplish in the first place.
To Your Success,