Starting a new business is an exciting yet challenging step not only professionally, but personally. Asset protection is a concept and strategy that will assist you in shielding your property and other assets that you own in the event that there is a legal claim against you. This Legal Kitz blog will cover all you need to know about asset protection for small business owners.
What is the risk of not having asset protection?
If your assets are not protected correctly, your personal assets may be exposed to unexpected claims. Business owners utilise asset protection techniques to limit the access that creditors may have to certain assets, all whilst remaining within the legal boundaries. Understanding the basics of asset protection will enable you to determine the best approach for your business and how to implement the most effective safeguards.
How do I make sure I’m structuring my business correctly?
There are four common frameworks to choose from when structuring your business:
- sole trader;
- partnership;
- company; or
- trust.
Each of the different structures require separate tax considerations and variables. Operating as a sole trader or partnership provides the least protection of your personal assets and relies on comprehensive agreements and insurance to provide some protection for your business and its assets.
To protect your personal assets, you should choose a structure that offers ‘limited liability’, such as a company or trust. You should note there is no 100% protection from liability in any business structure, however, limited liability structures offer a higher level of protection. You may also consider a structure with multiple entities for additional tax advantages, as well as furthering the separation between you and the risks of your business activities.
What is a company structure?
A company is a separate legal identity from its owners. It is considered a different person in the eyes of the law. This means the owners of the company are (generally) not directly liable for debts or liabilities of the company. High-risk businesses are best suited to a company structure, given its limited liability. Company structures also offer the advantage of making it easier to raise capital through issuing shares.
What is a dual company structure?
A dual company structure consists of a holding company owning 100% of the shares in a subsidiary operating company. As the owner, you may personally hold shares in the holding company, or you may hold the shares in a trust.
The holding company will hold, in addition to the shares of the operating company, all of the intellectual property and excess cash of the business. The operating company will be the entity that forms contracts with the clients, employees and suppliers.
The operating company is also the entity which bares most of the risk, while the majority of the assets are protected in the holding company. This structure adds an extra layer of protection. Any third party liability which arises from the business activities is likely to be born by the operating company, meaning most of your assets are protected. For example, if an employee sues your business, they will be suing the operating company (because that’s who they have a contractual relationship with).
What is a trust?
You may use a trust to run your business. To maintain the benefit of limited liability, you may consider appointing a corporate trustee, rather than an individual trustee. If your trust is held by an individual trustee, the trustee will be personally liable for the business’ debts.
All transactions of the business are undertaken by the trustee. The control of the business and the distribution of profits to the beneficiaries of the trust is outlined under a trust deed. The two main types of trust are the unit trust and the discretionary trust.
- Unit trust: The trustee holds the trust property and distributes the income to the members of the trust (unitholder) according to their interests in the trust. They are similar to companies in that unitholders can contribute equity as discrete units (like how a shareholder can purchase shares).
- Discretionary trust: The trustee has discretion as to who to distribute the income and capital of the trust. Beneficiaries do not have a right to demand a share of the income or capital. But the overall tax paid to the beneficiaries can be reduced by distributing income and capital to beneficiaries on lower marginal tax rates.
What does the corporate veil refer to?
As described above, when you have corporate structure, you have the added protection of limited liability. The separation of company and owner is known as the “corporate veil”. In exceptional circumstances, the corporate veil may be “pierced” or “lifted”, meaning you (as director or owner) will be personally liable for the company’s debts.
In your capacity as director of the company, you may be liable in some specific circumstances including:
- where the company does not pay its PAYG tax withholding and superannuation guarantee charge obligations; or
- where you breach your duty to prevent insolvent trading by the company.
If you are a director, make sure you have signed an indemnity deed (also known as an officer protection deed) with the relevant companies. Other circumstances where the corporate veil may be lifted include:
- where the company is set up for fraudulent purposes; or
- where the company is used to avoid an existing obligation.
Should I get insurance?
In addition, it is imperative that you attain the correct insurance policies to protect your assets in the event of any claim against your business. A directors and officers insurance policy should be taken out if you are also a company director.
You may also consider a professional indemnity insurance policy to protect you against claims arising from your participation in business activities. You should take this out for six or more years after leaving the business, to cover you beyond the limitation of actions period.
To ensure you are completely covered, you may consider taking out an umbrella liability insurance policy, which covers you for any other type of insurance necessary as well as WorkCover insurance if you engage workers or employees.
Should I make superannuation contributions?
Making concessional superannuation contributions may reduce the assets exposed to creditors’ claims. You should seek advice on how to maximise benefits by establishing a pattern of both concessional and non-concessional contributions. Likewise, seek appropriate advice if you have a self-managed super fund and ensure it has a corporate trustee, rather than individual trustees.
Can I move assets to family members?
You should consider transferring assets to other family members to protect them from creditors. This is particularly effective if your spouse is in a business or occupation which carries less risk. Strategies include:
- purchasing your family home in your spouse’s name;
- taking the home loan out in your spouse’s name;
- minimising personal contributions to the home loan; and
- transferring savings and investments to your spouse.
You should be aware of tax or other duty implications which may arise in establishing these arrangements. Further, to the extent that transactions are not at market value, the claw-back provisions under the bankruptcy rules may apply.
What is intellectual property?
Intellectual property (IP) may be your business’ most valuable asset. If you establish a corporate structure, ensure you assign ownership of the IP to your company through an assignment agreement.
Your IP will be better protected if you establish a dual company structure. This is because the IP will be owned by the holding company and insulated from the operating company’s day-to-day commercial activities.
Ensuring you have the proper contracts in place
One of the most effective tools for protecting your business and potentially your personal assets is by having the right contracts in place. These contracts will define your relationships and limit your liability with all relevant stakeholders, suppliers, clients and third parties. When a dispute arises, the contract that is in place will be the first point of call when determining the parties’ entitlements.
Asset protection strategies rarely work unless they’re implemented well before any adverse claims or liability arises. Strategies to protect your personal assets when doing business include:
- selecting the right business structure;
- maintaining your corporate veil (if applicable);
- purchasing the proper insurance;
- making superannuation contributions;
- moving assets to family members;
- protecting your IP; and
- having the proper contracts in place.
Legal advice
If you require legal advice or have any questions about our products or services, please do not hesitate to Legal Kitz by phone (1300 988 954) or by email ([email protected]).
The above information has been collected from relevant government websites and is subject to change. For the latest information regarding new or amended legislation, please refer to state and federal government websites.