Estate planning gives security

Separate business from investment and personal assets to protect wealth

Standard partnerships and sole traders are disappearing as growing litigation and liability exposure mean owners are choosing to trade through companies or other entities to minimise the risks to their personal wealth.

In reality, a proprietary company provides scant protection for personal assets and a more sophisticated strategy is required to safeguard wealth.

For asset protection, structuring businesses and personal investments correctly can minimise the financial impact of a business failure. It can also improve the operation of a business, minimise tax and protect it from some of life’s pitfalls.

Structuring

Debt and equity considerations

Equity, in the form of share capital, is the established means of financing mid-sized company businesses. By providing some working capital through loans, owners can provide a route to withdraw funds from the company as it grows and interest paid on loans provided by owners is tax deductible. Owners’ loans could be made to the company from an investment discretionary trust, controlled by the owners. Interest on the loans can then be allocated between the trust beneficiaries to minimise income tax on the income.

Owners should ensure their loans are appropriately secured and registered on the Personal Property Securities Register (“PPSR”). This will give them preference (in repayment) over unsecured creditors, should the company fail.

Directors’ guarantees

These should be avoided, if possible. Sometimes when a business is commenced they may be essential to get finance. If this occurs, make sure any guarantees are terminated as soon as possible and all relevant legal matters finalised on repayment (e.g. mortgages discharged on personal home).

Insurance

Use prudently. Assess risk and insure, where necessary. Directors of companies should have appropriate insurance to protect them against a variety of civil proceedings. Insurance cannot provide protection against criminal acts.

The operating company should also have insurance against eventualities such as product failure, loss of profits, loss / destruction of trading stock, theft by employees, buildings (owned or rented), plant and machinery, as well as workers’ compensation.

Adopt good corporate governance

Adhere to solid corporate governance principles when operating businesses. This includes setting up adequate internal controls with checks and balances in the company itself, as well as complying with health and safety and employee laws.

Also keep minutes to record the company’s decisions. You may need them to defend a legal action. An additional benefit from adopting good corporate governance is that insurance premiums should be minimised.

Succession planning

All good estate plans should have an exit strategy for active businesses as well as a succession plan, if a second generation is to run the enterprise.

The first principle is to look at the competency of the next generation. If family members are unsuitable, then appropriately skilled outsiders must be recruited for all important operational and management roles. Many family enterprises fail when the next generation are given responsibilities beyond their capabilities. Significant family disputes can ruin an otherwise successful enterprise.

Succession planning is a topic all of its own:


Separate business assets from investments

If structured correctly, only the operating company should be exposed to trading risks that is, claims from customers, financiers, creditors and so on. Ensure as many investment assets as possible are owned by a family investment company or trust. These structures can greatly increase asset protection if set up and administered correctly.

Land and buildings used by the operating company could be owned by the investment entity. A lease, on commercial terms, should exist between the operating company and the landlord.

If the business has intangible assets such as brands, patents and trademarks, these can be protected if they are owned by a separate entity from the operating company. The operating company would be licensed (by formal agreement) to use the intangibles and would pay the entity owning them accordingly.

The above arrangements can also raise operating efficiency by encouraging the business to pay market rates for using assets. This helps provide a truer picture of the business’ profitability.

Separating ownership of property (real and intangible) can help owners when they wish to exit their company by making the business more affordable to prospective purchasers.


Protect personal wealth

The principle is ‘own nothing, but control everything’. Adopting a prudential strategy can protect owners’ investment assets from a business collapse or liability arising from litigation and other claims.

Once this meant putting assets in the name of a spouse or family member, but now it involves more thoughtful planning, with today’s sophisticated bankruptcy and family laws.


Minimise the risks to business on death, divorce and estrangement

Lastly, protect the business from personal risks. It is vital to provide for death, divorce and estrangement.

A good will is an essential part of estate planning and memoranda of wishes should be drawn up by owners of businesses as well as by owners of investments. It is important for owners to explain to their co-owners, their own spouses and children what their financial structures are and how they would like them to operate after their death.

An inheritance or succession plan can help save major disruption to the business when an owner dies. A lengthy contest to determine control or ownership of businesses and inheritances can be fatal for family operated businesses and very costly to those involved.

Family law related matters can make control or ownership less certain, in the event of divorce or estrangement.

Conclusion

Good estate planning is complex and requires input from professional advisers including accountants or business advisers, lawyers and investment advisers to achieve the optimum results.