One of the many challenges facing small business owners when they start up, is managing the risk that the new enterprise places on their personal lives – not so much as far as family and time is concerned, as the risk the new enterprise places on their personal assets.
This is usually mitigated by the choice of placing the business into a limited liability company, where it effectively runs as its own legal person. The owner is then limited in his exposure to the value of the capital he has placed into the company to get things started up. His personal assets are generally kept safe from creditors of the business.
For creditors being asked to fund the business by way of lines of credit, overdraft facilities and loans, this is not ideal. The business is a start up with little track record, and they have little recourse to the management of the company if things head south. So for their own benefit, they ask all shareholders and directors to sign personal suretyships on the credit facilities (and often, a great deal besides)
That leaves the company in a position of being little more than a separate tax entity, for some owners, and of course a separate account of what happens in the business, as opposed to what happens in the rest of the owner’s life. (For many small business owners, this is one and the same thing.) With personal sureties in place, of course, the benefits of the limited liability entity fall away as far as protecting personal assets is concerned.
Many people see their own assets going down the drain together with the business as a result. Entrepreneurs being, well – entrepreneurial; and goaded on by Peter Caruthers in his delicious book “Crash Proof Your Business”, employed another strategy to stymie overzealous creditors. It involved keeping assets of the business in one company, which are then rented to the trading company in a tax neutral arrangement equal to the depreciation amount. The shares of both companies are in turn held in separate trust structures. Works brilliantly, as long as no criminal activity is evident in any failure.
But here’s the thing.
It appears that some trust practitioners have been abusing the goodwill of business people, and played on their fears to a stunning degree. I have seen several clients now with quite literally dozens of companies and trusts being set up for a single business. When questioned, they tell me “Sipho* calls every now and again, and tells me the law has changed, and another trust is necessary. Of course he charges handsomely to set up the trust, and then there are annual secretarial fees and independent trustee disbursements”.
I sat with a retired forensic auditor this last week, trying to sort out the affairs of yet another client, prior to him selling his business. He pulled no punches, as he said “Sipho is a crook”. He then showed me what passed for a structure, and showed me exactly how our client is at risk of tax authorities on three different continents.
[Hint: It is not ayoba to simply “change the trust deed” to suit the situation as it changes. When SARS suspects something is dodgy, it will lay waste with enormous penalties. Remember, with SARS you are guilty until you somehow prove your innocence.]
But there is a more immediate problem:
Buyers of businesses generally want an uncomplicated structure to buy into. When faced with a myriad of reporting, legal and accounting associations, any possibility of a tax efficient deal for the seller immediately goes out the door. No buyer in his right mind will want to inherit possible legal problems in the future. No buyer at all (in his right mind or otherwise) will want to take over someone else’s tax problems, particularly when he has no manner of understanding what has happened in the past.
There is a way of rationalising the madness of the past into a much simplified structure, and retain the safety as envisaged by Pete Caruthers.
Prepare Your Business For Sale.
Post Script: Several previously unknown readers called in me in the hours after first publishing this blog, and correctly guessed Sipho’s real name.
I know exactly who that crook is. I have been a victim and own 5 trusts
I have just been approached by a new client who has discovered the trustees of his Guernsey trust have opened his letter of wishes and disclosed information to the bank. He is currently asleep and shell shocked. So it is not just ‘Sipho’ Who turns the fees.