Asset protection lessons for Small to Medium Enterprises

7 February 2022

Asset protection is a key consideration in any business continuity plan, to not only protect the business but also its future owners including family members from the three ‘D’ of claims – debt, divorce & death.

Safeguarding your personal assets

It’s the front of mind concern for corporate directors or owners of small to medium-sized enterprises (SMEs): how do you appropriately protect your assets against creditors, business partners or personal relationship breakdowns or other claimants if something goes wrong?

The solution is to have a sound asset-protection plan in place that is implemented with rigour and continual review to reflect any change in circumstances.

It’s our observation that most clients aim for simplicity, but unfortunately simple structures often do not offer the best tax or asset protection outcomes.

It’s important when establishing a structure that it not only provides tax efficiency but also protection of non-business assets and accumulated wealth from claims against the business entity and/or its directors. Accordingly, any structuring should be tested against playing out the future ‘what ifs’. We walk through the below scenarios to illustrate some common traps.

Scenario 1– Protecting the family home and personal assets

Sometimes people think that establishing a business in a company or trust structure gives the owner the protection of the corporate veil and that creditors only have access to the company’s or trust’s assets, and this is generally true.

But as a director or trustee, if the structure has a deficit of assets to pay its debts, the claimant can sometimes access the personal assets of the director or trustee.

With prudent structuring you can mitigate such exposure;

• As covered in our recent newsletter, personal valuable assets such as the family home should be placed in the non-risk spouse name.
• However, for this strategy to be effective, it is essential to ensure this spouse isn’t in any ‘at risk’ positions like directorships or provision of personal guarantees for say, any loans of the business.

Scenario 2 – Your structures determine your personal liability

The way you have structured your business has implications not only for your tax but also determines your potential personal liability.

If you are a sole-trader or a small business your personal assets may be at greater risk than if you’re structured as a company.

A company offers many benefits as a business entity and one of the topmost benefits often pushed lies in its power for asset protection.

For example, a typical approach to structuring ownership of assets for a couple who operate a business is to:

• acquire their home in the name of the non-risk spouse – but not jointly;
• hold investment assets in an investment discretionary trust that is controlled by the non-risk spouse;
• operate the business through a company and have a single director who is not the spouse who owns the family home;
• for separate valuable business assets like key intellectual property, it may be appropriate to hold in a special purpose entity distinct from the trading entity.

Scenario 3: Loaning personal funds to the company

Capital is often required in business where it is not uncommon that the shareholders or family members loan their own funds to the company.

To help alleviate the risks, it’s important to properly document the particulars of the loan from the outset:

• ensure the terms of the loan are properly documented in a loan agreement;
• establish a security Interest as part of the terms of the loan ensuring that the lender can access assets of the company ahead of unsecured creditors if the debt isn’t repaid;
• where appropriate register the security interest on the Personal Properties Security Register.

Scenario 4: Giving personal or director guarantees

Whilst personal guarantees are best avoided altogether, they are often required by banks, landlords or other business alliances.

Consider the below when it comes to signing a personal guarantee:

• if the business is a family business, avoid having both spouses as directors of the company. Instead, the “at-risk” spouse takes on the business risk including the signing of personal guarantees and the other non-risk spouse owns the personal assets, such as the family home;
• a personal guarantee is not released upon the individual’s resignation as a director, or the company’s de-registration. The grantor’s consent is required to release the personal guarantee;
• if a personal guarantee is unavoidable, aim to limit the exposure by placing a financial limit on the liability as well as a time limit such as the period whilst a director.

Scenario 5: Contractual warranties and indemnities

It is common that a seller of a business will need to provide various warranties and indemnities to cover various representations made as part of the sale process.

It is justified to have multiple entities to hold different business operations so that any potential future claim under such contractual warranties is limited to that entity. For example, utilising separate business structures is used in industries such as property development.

Strategies to address exposures to valuable assets from risks created from such contractual obligations include;

• establish multiple structures for special purpose operations;
• this potentially extends to having separate trusts as shareholders for each company so that any warranties provided by the shareholder vendor is protected against dormant risk issues with prior contractual indemnities impacting on the value of future investments;
• commence wealth accumulation in other seperate entities that are not part of any guarantees or contractual warranties.

Scenario 6: Death of a director or shareholder

Departure of a key person in a business through death or illness can impact on the smooth succession of a business.

We have observed where these events have not been given due attention in the planning phase and often intentions are not realised. This could be due to family or shareholder dynamics, blended families, or lack of funding to buy out the exiting owner.

In such scenarios, negotiations fall into a state of stalemate and relationships become strained and broken.

One solution is to have a shareholder agreement and succession plan in place. These can be complemented by a buy/sell agreement to provide a mechanism for the succession of the business. It is also vital to give due consideration to the nomination of executors of a Will, the trustees and appointors of a trust and the shareholders and directors of a corporate trustee or other company. Understanding the interrelation between these governing instruments is vital, as commonly documents such as trust deeds or corporate constitutions don’t enable the intended plan of succession and it only needs one resentful relative in the wrong role to derail a carefully planned process.

Ten lessons learned

Below we list 10 practical lessons to take away from the various scenarios highlighted above;

1. Make sure you have the right structure in place;
   • Have a corporate trustee, rather than individual trustees;
   • Avoid running a business as a sole-trader;
2. Ensure trading operations are separate to passive asset-holdings;
3. Where possible implement a ‘non-risk spouse’ strategy to own the personal and family investments;
4. Consider the individual who controls your entities and review control positions such as the;
   • trustee;
   • directors of the corporate trustee;
   • appointors of trusts; and
   • separate as much control as possible from any “at risk” potential beneficiaries;
5. Review the succession and dispute resolution mechanisms in trust deeds and corporate constitutions;
6. Consider a Family Charter to protect the business, particularly for intergenerational businesses;
7. If there is potential for a will dispute or estate family maintenance claim, look at limiting the assets forming part of the deceased’s estate;
8. Review loans from directors or shareholders to companies and consider the terms of that loan and impact those loans have on the ongoing ability of the company to operate if those loans are called up;
9. Review status of charges including:
   • charges and security over assets; and
   • personal or director guarantees of debt;
10. Have adequate and appropriate insurance in place.

Next steps

A well-developed asset-protection plan should consider tax minimisation, estate-planning strategies, and intergenerational wealth issues. Because every person or family situation is different, there is no one-size-fits-all solution so seeking professional advice is important.

If you would like to understand the above measures in further detail, please contact the authors of this article.

This information is general advice only and neither purports, nor is intended to be advice on any particular matter.
No responsibility can be accepted for those who act on the contents of this publication without first contacting us and obtaining specific advice.
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