Business owners are, by nature, optimists.
To open and run a small business you have to believe in your industry, your ideas, your team and yourself.
Working with potential business owners to buy or set up a new business is an exciting time for all concerned.
Everything is bright, shiny and new – and pointed towards successful outcomes.
Many, via working hard and smart, achieve their growth and profit goals. Successful businesses can produce strong income for the owners and sometimes eventually be sold at a substantial profit.
But the sobering statistic is that 66% of small businesses in Australia fail within the first six months.
This failure can be for a variety of reasons – but most often it includes the business owners needing to deal with financial commitments left behind.
This is why, in amongst all the new business optimism, it is important to consider and protect against some of the worst case scenarios from the start.
Most new business owners spend money to insure themselves against events such as fire and flood, but often they don’t spend time and money protecting their personal assets against a claim via their business.
As many have discovered, when things start to go wrong, often it is too late to get vital protections in place.
Strategies To Guard Against Business Failure
1. Thorough Analysis Before Committing: Before handing over your hard-earned money to start or purchase a business, make sure you understand the specific industry and the overall market. If it’s a new business what is the potential market? If it’s an existing business how is it currently performing? Is the business located in the right area and does it have the right staff, stock and equipment? Does the business suit your range of interests and skills? Do you have to borrow money to buy/start and, if so, will you be able to source a loan and afford to service it? Sometimes the best way to avoid a failure is to avoid the mistake up front at the start. It may cost you some accounting and possibly legal fees – but normally a lot less than the fees required to help you exit a failing business.
2. Get the Right Business Set Up From The Start: Setting up companies and trusts may cost more than simpler set-ups such as sole trader and partnerships. But getting the right set up advice from the start can give you a much better chance of protecting your personal assets against creditors. There is not one business set-up that is right for everyone – it depends on the type of business, plus the personal assets and family situation of the people who will be the business owners.
3. Separate the Ownership of Business & Personal Assets: Prior to purchasing, make sure your personal family assets are not owned by those who will own and control the business. The simplest example of this is if the husband happened to be the owner and director of the business, then his wife could own the family house and other personal assets, thus better protecting the personal assets against any problems in the business. In some cases, two separate entities can be set up – a company to own the business and a discretionary family trust to own the personal assets.
4. Superannuation Can Protect Wealth: If business owners, in the normal course of events, direct some of their profits each year into superannuation, then it is generally protected from business creditors – provided it is done as part of the business owners long term wealth accumulation plan and not specifically in an attempt to defeat creditors.
5. Cost Issues: Many new small business owners approach a new business with a personal asset base owned in joint names. Transferring these joint assets can sometimes create both capital gains tax and stamp duty costs – and depending on the value of these assets these costs can be significant. For new business owners, it becomes a trade-off between asset security and these costs. In reality, not everyone can afford to do these transfers and fund the business purchase, but potential new business owners at least need to consider this trade-off as part of their business planning.
6. Timing Is Everything: Transferring assets as a business is nearing bankruptcy is likely to be unsuccessful as a strategy. Transferring assets well in advance of bankruptcy (greater than five years) has a much better chance of being successful, particularly if there are documented reasons other than asset protection for making the transfer.
7. Limit Personal Guarantees: When you start a business, just about everyone you do business with will want a personal guarantee from the owner of the business. Things like your property rental agreement, leasing office equipment or having an account with suppliers will all require personal guarantees from directors. In other words, if the business cannot pay, the director is personally liable. Make sure you know the terms of the documentation you are signing, keep a register of them and, where possible, limit these personal guarantees.
8. Know the Dangers on Your Balance Sheet : Many business owners draw money out of their accounts and accumulate these drawing as loans from the business, rather than declare and pay tax on them as wages or dividends. In a bankruptcy situation, the business owner can find themselves being asked by the liquidators to repay these loans to the business to satisfy the demands of creditors.
9. Beware Employee Benefits: The government, via the ATO, takes a very dim view of any business that does not pay wages, superannuation and other legal entitlements to its employees. Businesses that enter bankruptcy with these amounts owning will find the ATO very keen to pursue the personal assets of the directors.
So as you are planning your business venture, set aside some time and money to consider strategies that can help protect your valuable personal assets.
Source: Debt Affects Everyone (Asset Protection); Chris Cook, Partner, Worrells Solvency & Forensic Accountants.