What Happens To Your Business Assets In A Personal Bankruptcy?
This article was originally published on Forbes. For the original article click here
In my last article, we saw what can happen when a business bankruptcy intrudes on personal finances — with potentially disastrous consequences for an innocent spouse.
But what if you’re facing personal bankruptcy despite owning and operating a successful business? And what better way to examine that scenario than through a hypothetical using the biggest (in terms of estimated net worth) billionaire from the presidential primaries, former New York City mayor Mike Bloomberg?
When A Billionaire Isn’t Really
First of all, let me say that this article is completely apolitical; I’m only weighing in on financial considerations
Second, Bloomberg LP is doing just fine. This is the company Mr. Bloomberg founded, and his 88% ownership interest accounts for the vast majority of his wealth. There are no indicators a business bankruptcy is anywhere on the horizon.
But that doesn’t mean a personal bankruptcy isn’t a possibility.
Bloomberg didn’t stay in the race long enough to release his tax returns, so his personal financial position isn’t a matter of public knowledge. Given his Super Tuesday spending, it’s safe to assume he’s doing all right, but what if he wasn’t? Could his immensely valuable business holdings save him from personal bankruptcy, keeping in mind that value isn’t the same thing as liquidity?
Would his business assets be at risk?
What can other business owners learn by pondering these hypotheticals?
A Good Business Firewall Protects Against Bankruptcy Both Ways
Say you have a successful business — carpet cleaning, chemical sales, warehousing, etc. — that generates a healthy profit margin but is also fairly asset-intensive. On the personal side of things, you have a mortgage or two, maybe a HELOC, credit cards, you name it.
Paying the bills hasn’t been a problem thanks to the revenue your business generates. One major hiccup, though, and you could come up short. Whether you’re seeking to avoid bankruptcy or get through a bankruptcy as painlessly as possible, you’ll have to contend with three key questions:
- Must you sell your business assets to avoid or as a part of your personal bankruptcy?
- Can you sell your business assets to avoid or as a part of your personal bankruptcy?
- Should you sell your business assets to avoid or as a part of your personal bankruptcy?
If you’ve done your business planning right, the answer to the first question should always be no. Anything that restricts your freedom to maneuver is bad; if your business assets are attached to your personal liabilities, you’ve tied up potential revenue and may be forced into all sorts of unpleasant positions. And if you have any business partners, things only get uglier.
Putting up a firewall between your business and your personal finances is always step No. 1. And this doesn’t just mean separate checking accounts. You need to speak with an accountant and a business lawyer when you set up your business, and you need to maintain separation (for example, not using business assets for personal use and vice versa, though this can be more complex than it sounds) to ensure the courts, bankruptcy trustees and IRS will treat your business as a wholly separate entity.
When Facing Personal Bankruptcy, Strategy Is Everything
The answers to the next two questions are more complex, and are where the Bloomberg scenario gets interesting.
First, if Bloomberg were facing personal bankruptcy, could he sell his business interest and use the cash to cover his personal liabilities?
The former mayor would face a problem most business owners won’t — needing to find a buyer with $60 billion to make the purchase — but we can really just see this as a problem of liquidity. That’s an issue any business owner might face: Your business might be worth $1 million based on revenue, profits and growth prospects, but if you can’t find a buyer, that valuation won’t do you much good. Bloomberg and other business owners might also run into contractual barriers to selling. Merrill Lynch owns the remaining 12% of Bloomberg LP, and their partnership agreement may have a sales-prevention clause of some type or a key-person provision that would, in effect, drastically reduce the value of the business if Bloomberg were to depart.
Such provisions are even more common in smaller businesses. Think about it: How much of your business’s value comes directly from you?
You’re not a saleable asset, unless you’re willing to become an employee at a company you once owned, and even then, working out the right deal can be tricky.
That brings us to the third question: Assuming you can sell your business assets, should you?
Though his ownership stake in Bloomberg LP represents most of Mr. Bloomberg’s wealth, he also makes a lot of money from his business’s operations (profit and, presumably, salary). This is true for all successful business owners.
Are there valuable assets you can sell while keeping your business profitable? What would the tax consequences of such a sale and transfer of wealth from your business to yourself be? Are there partners who would need a share of the proceeds? Can you sufficiently cover your personal liabilities so as to make this move worthwhile? You’ll need answers to these questions and more whenever a personal bankruptcy is on the horizon.
It’s possible that some proactive business asset transfers can help you stave off a personal bankruptcy and maintain enough profitability to see you through. It’s possible that you may still benefit from personal bankruptcy, but close that chapter quickly using your business or some of its assets. And it’s possible that you’re better off keeping your business whole and rebuilding your personal wealth from the ground up.
Your best bet depends on your personal situation. Regular planning and reassessment and having a strategy in place for the worst — even when things seem to be riding Bloomberg high — will help diminish the panic that can hit when your personal finances take a nosedive.