Don't lose your business and your shirt!

01 February 2009 Jose Delgado, iProtect

Between 80% and 95% of small businesses fail within the first five years. How does a business owner minimise personal risk and loss in the event of business failure?

While most people start a business with great enthusiasm and optimism, once the euphoria subsides, the reality of running a business kicks in. Business owners are faced with cash flow issues, labour law hassles, claims from creditors, landlords, bankers, financiers, potential claims for damages arising from the service or product, the possible death of the business owner, or a partner in the business passing on, becoming disabled or running into personal financial difficulties.

All of these events could affect the success of the business and the potential of the business failing becomes a reality in which the business assets, the income streams, and the business owners' personal assets, including their homes, could be lost.

Right structures

The scenario above is often the consequence of carrying on a business as a sole proprietor or as a partnership. As a result, the English innovated the concept of limited liability by creating a Closed Corporation (CC) or a Company (PTY Ltd). Limited liability means that the losses or claims against the business are limited to the legal entity which conducts the business, protecting the owner as an individual. This worked well until creditors began insisting that the beneficial owners and other third parties guarantee the debts and obligations of the CC or Company via sureties and collateral such as property, effectively negating the protection offered through trading in a CC or Company.

A sensible alternative

The solution is to ensure that the correct structure for the business and the business owner is established to provide proper asset protection, risk mitigation and efficient tax planning. This can easily be implemented through the correct utilisation of Companies or CCs which are owned by trusts. A trust will not only protect business owners from the scenarios detailed above, but will also protect the business from the owners. Very often an individual's personal circumstances or other business dealings, guarantees or sureties could affect the business, and this is particularly problematic when more than one person owns the business.

Added benefits

In most profitable businesses, all the profits accumulate in the hands of the owners. This position is less than ideal, as these accumulated profits are susceptible to attachment by creditors. In addition, should the owner pass away, some very inequitable scenarios may arise, such as the payment of Capital Gains Tax (CGT) on the growth in value of the business, even if the business is not sold or even if a lower price than the valuation at time of death is achieved on a sale. Coupled with CGT, the business, shares or members interest value will be valued as on the day before the owner's death and will be subjected to estate duty. The latter scenarios can be easily avoided if the business is correctly structured using a trust.

The correct structures for the business, coupled with the correct personal structures, will ensure that in the event of a business failure, life goes on with the business owner holding on to all his or her assets, albeit with a bruised ego, until the next business opportunity arises.

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