Protection of personal assets

By Frans van Eden, AGA (SA)

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When you first start dreaming of your own business you wake up with starry eyes, imagining how you will conquer the business world with customers falling over each other to do business with you.

The reality is unfortunately not as bright and one of the things that you need to contend with is customers who do not pay in time, which places your cash flow under pressure. This in turn causes you to scramble for cash to pay your staff and suppliers in time, and the temptation of using VAT to cover your overheads. This is also a slippery slope that can lead to bankruptcy of an otherwise successful business.

The first step to protecting your personal assets from your business’ creditors, is that you need to understand that the corporate structuring of your business determines how much of your personal assets are at risk.

Business vehicles

In South Africa there are 5 business vehicles available to the general public and all of them have their pros and cons:

  1. Sole-proprietor

This means that you are the business. Therefore, there is no separation between your personal and business assets. The negative is that there is also no separation between personal and business liabilities and defaulting on either place all your assets at risk.

In the olden days there was the benefit of lower income tax on profits, but this has been negated by the small business corporation and micro-business tax benefits available in a CC or private company.

  1. Partnerships

The main reason for the existence of a partnership is to enable people to work together in a structure where they shared in the profits of their business ventures. Partnerships are a very old form of trading as it was invented before the first companies or close corporations came into existence. The cons are the same as a sole-proprietor with two additional negatives thrown in, being that the actions of any one partner is binding on the entire partnership, and that all partners are jointly and separately responsible for the liabilities in the partnership.

This effectively means that should John D. enter into an agreement with a company to deliver goods and services, the entire partnership is bound to the agreement, even if he was not mandated by the other partners to do so.

Let’s consider the second negative, being jointly and separately responsible for the liabilities in the partnership. Imagine this: the partnership is 10 years old and there were some very good years where they achieved high profits (selling camera film) and as it was a 50/50 partnership with all profits were divided among the two partners. Partner A saved most of his money planning to go on an around the world trip upon retirement and he settled the bond on his home. Partner B lived the life of a party animal and mostly spent his money on alcohol and holidays.

With the invention of digital cameras and cell phone cameras people stopped buying film and over a period of 5 years the business was closed due to bankruptcy. The total liabilities amounted to R10 000 000 with no assets left in the partnership. Partner A’s personal assets amount to R7 000 000, including his home, while Partner B’s personal assets amount to R3 000 000. In such a scenario the creditors will take all their personal assets to settle the partnership’s debts but as you can see Partner A will lose a lot more than Partner B even though they were only 50/50 partners.

  1. Companies and Close Corporations

These are the first entities that offer protection of personal assets against creditors. In theory you can only lose that which you put into the business. Reality is somewhat different as most lending institutions require the directors of small businesses to sign unlimited suretyship when borrowing.

This means that any of the business’ creditors, to whom you gave this suretyship, will have a claim against your personal assets should the company or CC be declared bankrupt.

All other creditors will have to write off the debt, provided that they cannot prove gross misconduct on the part of the directors/ members as the companies act states that director/ members are personally liable to creditors where gross misconduct occurred.

To ensure that you can’t be charged for gross misconduct means that all minutes of meetings should be kept, including stating why you considered taking out a loan with all considerations given to threats to the business and projected cash flows.

  1. Trusts

A properly constructed, and managed, trust is the only vehicle that can offer real protection from personal creditors as the trust’s assets vest in the trustees and not in the founder or the beneficiaries of the trust.

A properly managed trust keeps minutes of all decisions made with regards to monies received, monies spent and use of trust assets. You should see a trust as a vault, anything that goes in should not be allowed to go out again unless you complete all the paperwork, and if an asset is in the vault the asset is protected. Once again it must be stated that should the trust sign surety for any of the business’ or an individual’s liabilities this protection is voided.

I am however not of the opinion that trusts are the ideal vehicle to conduct business in as trusts have the highest tax rate of all the corporate structures in South Africa, and yes,  there is the conduit principle that allows you to distribute profits to beneficiaries where it will be taxed at their tax rates ,and not that of the trust, but this is not the main purpose of choosing a trust in today’s article as business activities open up the trust to claims from creditors which once again negates the vault principle.

Conclusion

As you can see from the above it is important to have a mix of different structures in your group to reap the benefits of each while negating the cons of each. See it as a puzzle made up of different pieces to make the whole but each person’s puzzle will look different from the next so it is important to speak to an expert before implementing.


Frans van Eden, AGA (SA) is MD of Prioritise, specialising in tax planning, insurance, financial advice, accounting and corporate structuring. Email frans@prioritise.co.za to arrange a free consultation. www.prioritise.co.za

 


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