There are so many things to think about when getting a startup off the ground, and ensuring your assets are protected appropriately is an item that’s often overlooked. In some circumstances, you may find that the standard structure just does not suit your needs.
There are several situations where operating a business or owning assets in either your name or your company’s name is not suitable, and you may have a number of reasons to avoid these structures. Let’s look at what these situations might look like and your options for protecting your assets.
What does asset protection really mean?
Asset protection can be a complicated subject. It generally covers the process of assessing your existing assets and their ownership structures (for example, is your vehicle owned by you as an individual, or was it purchased through your company?), comparing these assets against your potential risks, and developing a structure that best protects you and your company from creditors, legal action, and other losses.
There are two key pieces to effective asset protection:
- Protect company assets
The most common method of company asset protection is utilising a holding company and trading company working in unison. This protects the financial assets and intellectual property of a company.
- Protect personal assets
Company founders should always take on personal consideration of whether additional asset protection steps are necessary. This covers personal assets and protecting assets like their company shares from creditors, and is usually done through a discretionary trust.
Why is asset protection important?
Startups are relatively risky businesses, usually operating on fine budget margins and without a lot of cash. Also, moving fast and expanding rapidly can often mean that a startup is not very well organised. This is especially the case for startups that don’t get a lot of legal advice or cover all of their risks very well.
For example, some startups may hire a lot of staff as they expand, but then realise that they haven’t checked the minimum pay rates properly, or that a lot of their ‘contractors’ are actually employees. This can result in the business suddenly having a huge new liability that it cannot afford to pay. This is just one example, but there are a million ways in which a startup can find itself in a situation where they cannot pay a creditor, or they are sued for a large amount by someone.
A good asset protection scheme would provide a measure of protection to the startup against these scenarios and help minimise the harm that results from it.
How do I set up a good asset protection scheme?
Set up a holdings company
A good way of protecting the assets of a startup would be to set up two companies that are linked to one another in a business sense. One company, your ‘holding company,’ should own or ‘hold’ all assets. The second company, your ‘operating company,’ should conduct the daily operations of the business. These two companies are linked by a contract – consider it a service agreement, operating agreement, or licence whereby company one, who holds the assets, contracts company two to carry on the business activity.
The holding company should hold – as the name suggests – just about everything: most of the cash and financial assets, any valuable material assets (real estate, plant and equipment etc) and also intellectual property such as software, code, brand rights, business names, trademarks, patents, and more.
In the above scenario, company 2 (the operating company) is liable for any legal action brought against them in the course of daily operations. However, because company 1 (the holding company) holds all the assets, these assets are protected. Company 2 can dissolve if legal action is brought against it, without any risk to the actual important assets of the business. Company 1 can then just incorporate a new operating company (company 3) and start again.
Hold your shares through a discretionary trust
To take things a step further for the purpose of personal asset protection, company founders should also consider if a trust suits their financial needs. It’s a smart idea, because although a trust is for a founder, personal circumstances can also impact the startup. For example, if a founder defaults on their mortgage or gets sued for any reason, they could end up in bankruptcy. In such an event, any shares in the startup which the founder owns could be sold as part of the bankruptcy process. Losing the founder and potentially getting a stranger as a new major shareholder would not be a good outcome for the other founders or the startup itself.
How does a trust work?
The most common asset protection structure is achieved by setting up a trust. Generally, the main reason someone sets up a trust is to protect assets from creditors, but a trust may also provide more flexibility with taxation for founders. A discretionary trust is often the most advantageous structure for personal asset protection.
- What is a discretionary trust?
A discretionary trust is a trust which allows the trustee to allocate the trust property (the contents of the trust) to the beneficiaries in whichever way they desire. It’s called a discretionary trust because the trust is distributed at the discretion of the trustee. In this type of trust, you (as the trustee) could decide to pay 10% of dividends to one beneficiary and 90% to another. This setup method is flexible and particularly useful when you need to consider an uneven split between beneficiaries that may change in the future.
A trust is an effective method of asset protection, but trust setup can also be a tricky thing to get right. Standard trust packages often don’t cover many individual requirements, which can lead to problems down the line. Setting up a trust should always include getting legal advice before proceeding.
Take, for example, the case of Lauren and Julie. Lauren owns a small company, and she’s been married to Julie for five years. Because Lauren is making a substantial salary as CEO, but Julie is currently working part-time as she completes her Ph.D., Lauren wants to pay dividends to Julie to so that less tax is paid on the dividend. In this instance, she would need to set up a trust, issue shares to the trust, make Julie a beneficiary of the trust, and then pay out those dividends to Julie.
Sounds easy, right? But in reality, Lauren must comply with multiple tax considerations, a considerable amount of structuring, and stringent legislation. It would be easy to set up the trust incorrectly and lose all tax opportunities.
With many options and variables, it’s recommended to obtain legal advice on setting up a trust that best suits your needs. A trust should always be tailored to specific circumstances.
Asset protection is an integral part of running a business and protecting your financial future. A holding company is often the most efficient way to put this into place, but setup can be difficult and complex. If you’re also considering a trust, be aware that a trust often needs to be customised to very specific circumstances. For this reason, it’s always recommended to have a legal professional assist with asset protection setup.
UX Law can help you create your business structure and set you up to appropriately protect your financial assets.