When you first start your business, you’re probably not thinking about what happens if it fails. But planning ahead for the worst-case scenario, even when the outlook seems calm, may save your home and personal assets from creditors.
Why do you need to protect your personal assets?
Running a business involves risk. Risk of trading errors and mistakes; risk of negligence; risk of your business being dissolved with debts and creditors that the business can’t pay. These risks not only mean your business assets may be used to pay back debt, but if you don’t take certain steps in advance, they may place your personal assets squarely in the firing line for auditors and creditors.
Fortunately, there are strategies you can employ which makes it less likely that you will be personally liable for debts and obligations of your business.
Eight strategies to protect your personal assets
- Choose the right business entity
There are tax and legal implications that you need to take into consideration when you set up your business. While a sole trader may be the easiest entity to set up, it’s not going to offer any protection for your assets. If you set up as a sole trader and the business fails, your personal assets are completely exposed to creditors.
A limited liability company offers protection for your assets. While it may require more paperwork to set up, it’s not difficult and it’s worth it to protect your assets.
- Maintain your corporate veil
Set up your limited liability company properly. It costs almost nothing to have a separate bank account and credit card, and even less to ensure your company name is used correctly on all relevant documents. Record business-owned assets correctly in your general ledger, and have personal assets kept separate in your name.
Most importantly, complete company documentation correctly. This includes AGM minutes and all corporate records. This all helps to establish a clear demarcation between the business and your personal assets.
- Use proper contracts and processes
If you, as a director, act fraudulently or with negligence, then it’s far easier for creditors to try and obtain your personal assets. Avoid this by ensuring all paperwork is legal.
- Leases are in the company name
- Property and equipment is purchased correctly by the company
- Having subcontractor agreements in place
- Create a contract for every project
- Ensure there are hard copy documents for the terms and conditions for agreements with suppliers and customers
- Never hire people to work under the table.
And finally, read every contract before you sign. Make sure it’s in your company name, not you personally.
- Purchase appropriate business insurance
Insurance is your biggest protection against risk. Not just physical risks such as earthquakes and fires, but also intangible risks. Liability/ indemnity insurance protects you from mistakes or negligence. If a staff member steals from you, or a contractor does a shoddy job, insurance may cover you and ensure you’re not left out of pocket.
If you cause harm to someone or a business through your dealings, you might find yourself personally in trouble. Talk to an insurance company and find out what insurance cover is a nice to have, and what is absolutely essential for your business set-up.
- Consider a Family Trust
You’ll need a lawyer and/ or accountant to advise you on this, as it can be fraught. A family trust can add a layer of protection for the directors of a company. If set up and used correctly, you can transfer the family home and other assets into the trust, making you an individual who owns no assets of value. The properties will be owned by trustees of the trust and held for the benefit of the beneficiaries.
However, this doesn’t mean that all your assets are ‘safe’ from creditors. If the trust is set up incorrectly, assets can be ‘clawed back’ and considered your personal property. In that scenario, these assets will be used by creditors to pay back any outstanding debts. Furthermore, if you transfer assets to a trust too close your business experiencing financial distress or personal bankruptcy, assets may be clawed back. So the time to set up a trust is long before you need its protection!
- Don’t give personal guarantees
When seeking a business loan, you may be required by the lender to give a personal guarantee. This means that if the company defaults or can no longer afford to pay the loan, the lender will expect you personally to pay it. If you cannot afford to pay it, the bank can foreclose on your assets.
If you can avoid giving a personal guarantee, do so.
- Carry out asset inventories regularly
Record every business asset. From property to IT, vehicles to equipment, everything should be purchased in the business name and recorded as such in the general ledger.
For instance, if the business owns a vehicle, it needs to be recorded as such, have depreciation accounted for, and have its expenses paid for by the business. This means that if you personally get into financial trouble, the car remains safe in the business.
- Seek professional advice
There is a lot of advice out there and not all of it is good. Talk to your trusted financial adviser first who will also let you know when you need to speak with your lawyer and/or accountant.
This is one area where a DIY approach is not recommended. If you don’t structure your business correctly and strictly comply with relevant laws, you may find yourself personally liable for business debts. To check to see whether you have the right protections in place, call your financial adviser today – you don’t want to lose it all.