All good businesses will use a risk minimisation strategy of one form or the other. For many small business owners, their strategy is simply to comply with the law and to try to only deal with good people. Unfortunately, bad things often happen to good people.
In this article we will explore a few of the legitimate ways to protect your personal or business assets from potential claimants.
Asset protection: what is it?
At its simplest, asset protection is about safeguarding your key disposable assets (business and personal), by preventing others from accessing and taking them. A carefully constructed asset protection strategy can help you avoid personal liability by creating a barrier between the potential claimant and your assets.
Asset protection can take many forms. Generally speaking, most mechanisms will involve a separation of key business assets from the trading entity, coupled with complimentary insurance cover (for example, professional indemnity and public liability insurance). For asset protection and tax purposes, the valuable business assets are commonly held by a related company on trust for a designated trust entity.
Which structure is appropriate for you will depend on your business experience, type of business (high risk vs. low risk) and the size of your business (including the number of owners).
How do I protect my key assets? A case study.
Much like keeping valuables in a safe, a ‘secure’ and separate entity can be used to store the key assets of the business away from the income generating business.
For many small businesses, the structure can be achieved quite simply and with little or no disruption to the trading operation. As an example, (fictional company) Bizco, is the sole entity through which a group of professionals conduct their business. Bizco operates the day-to-day business, employs all the staff, leases the premises and owns the goodwill.
To separate its key assets from the trading company, a new entity ‘Holdco’ is established to hold the assets used by Bizco. This is achieved by entering into agreements that simultaneously:
- transfer the key assets to Holdco and then
- licence them back to Bizco, usually for nominal consideration.
Most assignments of lease will require the lessor’s prior consent – but once approved, Holdco will become the tenant and will, again, with the lessor’s approval, sub-let the premises back to Bizco.
When the structure is in place, if Bizco is sued, the key assets are protected because they are owned by Holdco and are used under the licence agreement.
Use of trusts
As well as separating the assets from the trading arm of the business, lawyers will often recommend that a trust is the most suitable entity to own the business’ assets. This particular structure will offer an additional layer of security contemporaneously with the separation of the business assets. Essentially, the trustee will have legal control (which is legal title only), while the beneficiaries of the trust are entitled to the actual assets and profits of the trust.
The basic function of a trust is to separate control and ownership. Once installed, and so long as these elements of control and ownership are kept separated, the trust structure can provide effective asset protection and can be used to distribute company profits in a more tax effective way.
In our example above, if Holdco were made the trustee of a trust, it would still own the goodwill, IP and other business assets in its own name. It would also still have the power to licence those assets to the trading entity (Bizco) but, by virtue of the trust deed, it would have agreed to hold those assets (and profits generated from those assets) for the benefit of the beneficiaries nominated by the Bizco proprietors.
If structure was implemented, despite Holdco having legal title to the assets, a claim against it may prove futile because Holdco is only the trustee of a trust and does not therefore own the assets. Instead, the assets are held in trust for the beneficial owners, so nothing can be taken from Holdco as it does not own anything beneficially in its own right.
Directors’ personal liability
Having a neat structure like the one described above cannot completely protect directors from their own personal liability for certain obligations. These include:
- some losses (specified in the Corporations Act) suffered by shareholders or third parties as a result of their actions (or inaction); including debts incurred when the company becomes insolvent and company losses caused by a breach of the directors’ duties;
- the amount the company should have paid under the PAYG withholding system or the super guarantee provisions;
- if you act as a guarantor or provide security over personal assets (for example if you have taken out a lease or applied for business finance); or
- losses caused by your involvement in illegal phoenix activity.
This being the case, in addition to the protection of the business assets discussed above, it is prudent for directors to take steps to shield their personal assets from potential claimants. Most commonly this is achieved by transferring personal assets (such as the family home) to a spouse or trust.
There are several ‘layers’ of protection that are available to business-owners to protect their key assets. What is appropriate in your circumstances will depend on the level of risk the trading entity is exposed to and the value of the assets in question.
- Wherever possible, you should use a separate legal entity to hold the business assets, away from the legal entity or activity that poses the risk.
- Having assets carefully ‘locked away’ is a powerful deterrent to would-be claimants.
- Company directors need to adopt additional protection measures given their exposure to personal liability for company debts.
- Tax benefits to business owners are often a welcome side-effect to careful asset protection.
The information provided in this article is general in nature and does not take into account your own specific circumstances. You should seek the advice of a lawyer with recognised expertise in your industry prior to acting on any of the issues discussed.
If you want advice as to how to protect your assets, please contact our Corporate and Commercial team for advice.
Female baker putting a baking tray full of rolls in oven by Jacob Lund