Are your assets protected in your business structure?

The first consideration when choosing your business structure is how you can best protect your personal assets, like your home, your car and so on.

Running a business can make your personal assets vulnerable in a number of ways – should you ever get sued by a client, partner or supplier; when you need to borrow money from a bank or other trading partners; and should something happen to you as the owner.

When it comes to liability, there are a range of reasons why you might get sued. Knowingly or unknowingly, you might not complete work in the manner a client was expecting, you might violate employment laws, you might violate terms of a partnership agreement and more. If a court finds you guilty, you will likely need to pay a financial sum to the other party involved in the case.

Where does the money come from?

This is where your business structure comes in. First, it’s important to adequately insure against the possibility of being sued. However, if that is not possible, or if the sum you have insured yourself for is less than the payment you need to make, your personal assets could be vulnerable.

Instances where insurance protection may not be possible are when you, the business owner and/or your employees, are found to be in fault for specific wrong-doing. As a business owner, you would not likely be performing any deliberate act which would cause damage to another party. If, for some reason, this occurs, insurance will not protect you. Similarly, should your employees cause such damage, you will likely be liable. You need to vigilant to ensure as best you can that these occurrences do not eventuate.

Dealing with unscrupulous individuals is also likely to limit your protection, as are conflicts of interest. In these scenarios, physical damage does not have to result for you to possibly find yourself in hot water. Ensure that you and your company’s ethics are always above reproach.

Acts of nature can also limit your protection so, where possible, you should incorporate into your contracts relevant clauses which do not hold your company, your employees and yourself liable for such acts.

All in all, this area can become a legal minefield, so I strongly recommend you have in place all relevant insurances for you and your business.

If you run your business as a sole trader, you and the business are considered to be a single entity. This means that, if the business is sued, your personal assets are fair game. In order to pay the mandated sum, you might be forced to sell your home, and any other assets you have.

By contrast, if your business structure was a company or a trust, that is considered to be a separate entity. As a result, your house is not likely to be at risk.

Similarly, if your business is likely to borrow money, whether it is from a bank or other trading partners, it is important that it has enough assets to satisfy these creditors should you be unable to pay a loan.

Again, if you and your business are a single entity, you might be required to sell your personal assets to pay back your creditors. By contrast, if your business is in a separate structure, assets owned by the business may need to be sold off to pay any debts, but your personal assets will be protected.

Keep in mind that, depending upon your actions and also the bank’s conditions of lending, complete asset protection may not be able to be achieved. The government and the banking industry are continually putting measures in place to try and limit your ability to be shielded by separate business structures.

The third area to consider when it comes to asset protection is how you can protect your assets should something happen to you. What will happen if you get sick or injured? What will happen if you pass away? What will happen if you divorce and your spouse makes a claim, or if adult children want control of the business?

Other than having all your personal health and life insurances in place, the type of entity you operate your business in could impact what happens to your business.

If you can no longer operate the business, for example, the type of entity will determine how ownership and/or control of the business can be passed to other family members without triggering tax or incurring excess costs. A trust may provide the ease of transfer without triggering tax and costs, whereas a transfer of the assets in a company will incur capital gains tax if there is an increase in value in the business.

In the case of divorce, you may wish to protect your business interests from your estranged spouse. If you operate your business in a company and you and/or spouse hold shares in that company, then protection may not be possible. Should you hold this business in trust and there are a number of beneficiaries, none of whom are presently entitled, then protection would be more likely.

Finally, just as you want to protect your personal assets from your business, you should also try and protect the assets of your business from your own personal assets.

For example, if you are starting a property development and you also own and operate a painting business, you will want to make sure you protect the assets of the property development from claims of the creditors of the painting business.

Your options for structuring the new property development business include running it as a sole trader, in partnership, as a company or as a trust.

As an individual, because you are also the sole director and shareholder of your painting business, your property development would be totally exposed and therefore vulnerable to the creditors of your painting business. This option would not be ideal.

In a partnership, your vulnerability will depend on the partner and whether your partner has ownership of any significant assets. For instance, if you form a partnership with your spouse and the family home is in your spouse’s name (because you wanted to protect that against the painting business), you would still be exposed and vulnerable to the creditors of the painting business for your share of the property. In addition, your spouse is now also exposed. Again, this option would not be ideal.

Let’s consider a company using the same set of assumptions. You would need to determine who the director/s and shareholder/s would be. If it was you, you would be potentially exposed via director’s personal guarantees. If it was your spouse, the family home would be exposed. So, unless you can make someone else the director, this option also would not be ideal.

The final option is a trust. When considering the same set of circumstances, a trust is definitely an option. Earlier in this chapter, in the section ‘What are your options’, I explained briefly what a trust is and the benefit of a discretionary trust. To elaborate further, the trustee of the trust is charged with the responsibility of administering and managing the assets of the trust. If the trustee was an individual, then that individual trustee’s personal assets could be exposed. If, however, that trustee was a company, then the company would be exposed. The benefit of the company is that it will not own any assets and be limited to its shares, for example $10. That is the extent of its exposure. Therefore, a discretionary trust structure (with a corporate trustee) will provide the best form of protection against your painting business and also against your personal home. In addition to the above benefit, the trust does not have any individual beneficiary who is presently entitled to the assets of the trust and therefore no creditor has access to the assets of the trust. The trustee controls the trust and as such no beneficiary has a fixed entitlement. This is definitely the best option in this example.

As you can see, asset protection can be a very sensitive issue and is one that needs your utmost attention.

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