Written by Allard Bailey Family Law.
As an entrepreneur there is always an overlap between your professional and personal life, so it is important to understand how the decisions you make in your private life can impact your business. In this article we are going to focus on four big life events that can affect your business and share some cost-effective legal steps you can take to limit the impact they will have. They may not seem relevant right now, but there is at least one that will affect all of us and it’s important to be aware of the potential impact of the others so that informed decisions can be made about the protections against them.
In our experience hard-working business owners tend not to consider their absence as a serious possibility, so they make limited preparations for the operational impact of their sudden disappearance. The reality is that anyone can become incapacitated at any time through illness or accident, so it makes sense to prepare. Depending on the length of time you are out of action, the impact on your life may be minimal, but the consequences for your business could be more significant.
What will happen to your business if you find yourself or a business partner unexpectedly unable to work? What would happen to your business if you couldn’t give instructions, sign agreements or authorise payroll? It’s a sobering thought.
For this situation a Business Lasting Power of Attorney is highly recommended. Business LPA’s are a form of property and financial affairs LPA. As with all LPAs, this is a formally registered document, which assigns one or more trusted people (called attorney’s) to help you make decisions or to make decisions on your behalf if you are unable to do so.
Most people will have only heard of an LPA in relation to an elderly relative assigning attorneys to take care of their health and welfare or personal finances so it’s really important to appreciate that there are different applications for them. They are just as relevant, if not more important for business owners as the business can’t stop functioning just because the owner has to take a temporary or even a permanent break from it.
Business LPA’s concentrate solely on your business and more specifically, how you expect your attorneys to run your business when you are not able to. They can even state whether you wish the business to be sold in certain situations. This is important because the profits that are generated from the business still belong to you and will probably need to sustain you.
Properly drafted, a Business LPA can be used intermittently, so if you find yourself needing assistance one week you can ask for your LPA’s to be used but resume control when you feel able to deal with things yourself.
Although you can include your business in a standard Property and Financial Affairs LPA, it is advisable to separate your business and personal affairs as much as possible to ensure you have the most effective people looking after the different areas of your life. For example, you might nominate a parent as your personal attorney to look after your bank accounts and health decisions, but you might find that trusted employees would be more effective guardians of your business.
LPA’s may seem straightforward but without the relevant legal knowledge many people include instructions that just don’t work in law, or leave sections blank where they could and should have provided detailed instructions covering different eventualities.
For example, many people are not aware that if you have investment assets that are looked after by a financial advisor, you must make a specific provision for that financial advisor to continue their work taking instructions from your attorney or they will be unable to do so. If this is not included in an LPA, the person looking after your affairs will need to get a Court Order for your Financial Advisor can continue their work.
A common misconception that leads people to ignore LPAs is they assume their spouse can get automatic access to their assets if they become incapacitated. Unfortunately, that is not the case, your spouse cannot sign or make agreements on your behalf even if they are a joint business owner. If two signatures are required, two signatures will always be required.
If you don’t have an LPA, those around you have to apply to the courts for an appropriate order to manage your business, and this is not a situation you want to be in because:
- They are costly – much more than taking legal advice to prepare your LPAs;
- They can take a long time to complete – sometimes up to 9 months and it is unlikely that your business is going to be able to wait that long to have someone fill your shoes;
- The person the court appoints may not be your first choice or your choice at all; and
- There is less freedom of management of your affairs under court orders.
Unfortunately, death is a reality we all have to face at some point, and we won’t get to decide when. So, the best thing we can do is face it head on and protect our business from the unexpected. One of the ways this can be done is by making sure you have a valid and up to date Will, which not only dictates what should happen to your personal assets, but gives clear instructions about how things should work with your business when you are no longer around. We call this a Business Will.
Without a Will, your business may effectively stand still until the administration process is completed. That is not going to be practical if your intentions are for your business to continue after your death or for your heirs to receive the maximum sale value.
Business Wills give specific consideration to your business, its assets and what happens to them on your death including how they should be managed until your heirs can inherit.
Some of the matters that require consideration in Business Wills are:
- Executors and trustees – these are trusted people that you nominate to look after your estate and transfer assets to your loved ones when you are not around.There are very few businesses that can be put on hold when there is a death so your executor may have to step into your shoes as a director and make business decisions until your beneficiaries are able to take over. As with LPAs, the people you want to take control of your personal assets are not necessary the same people that you would nominate to look after your business.For example, your spouse or parent may be fine in sorting out your bank accounts and the family home, but they may have no idea to run your business, especially if it is controlled under regulatory circumstances such as a dental practice. In a situation like this, a business partner or even a trusteed employee could be a more effective executor.In addition, executors/ trustees are not usually allowed to charge for the work they do. If they have to become a director of your business by virtue of being an executor/ trustee they would either need to do so for free, which might be unrealistic, or you will need to make appropriate provisions to ensure that these people are properly remunerated for their time and efforts.
- Shares and assets – It is important to differentiate between shares and assets. How do you envisage your company structure to continue after your death? Some may want the business to continue as it is and will ensure that it is passed as a whole to loved ones. The most common way to do this is gift the shares of your business. Other’s may have personal circumstances which mean the business will have to change. For example, if you have a situation where your loved ones are not going to be able to work together in one business, you may have to carve up parts of it or you may decide to leave your business to one person then compensate any others by giving them a greater share in your personal assets.Some assets frequently get overlooked in normal Wills, such as intellectual property rights. Who will have the rights to your trademarks and patents? Who will receive royalties and what is the most effective way for this to happen? These are all important conversations to have with your advisor.
- Trust Structures – Trusts are a common feature in Business Wills. They allow an entire business to pass into a trust structure on death. Most trading businesses will qualify for something called business relief. This means that the value of your business is not subject to inheritance tax on death. By transferring it into a trust on death, it gives your family time to consider what would be in the best interest of the business and how they want the operations to progress.
A well written Will is important if you would like to pass some or all of your business to your partner if you are unmarried, step children, business partners, and/or staff who are not legally recognised as your heirs.
Divorce is another topic that most people prefer to avoid. However, with 42% of marriages said to end in divorce it is another possibility that your business may need protection from. Why? Because marriage is a contract that starts on the promise of ‘what’s mine is yours and what’s yours is mine’ so if your relationship fails, the starting point is usually that your spouse is entitled to 50% of everything you own, including your business. That might seem fair in theory, but the reality can be very different.
Businesses can be difficult to value for divorce and difficult to divide. Is it even fair to try to divide something that only one person has invested time or effort in, especially if the other person is employed with their own income? It is really important to think about that at the beginning of a relationship and consider whether you should ring fence that asset or make some other type of arrangement to ensure you could both be fairly provided for without harming the business that has employees and customers to consider.
Pre-nuptial Agreements allow you to enter into your own agreement and vary the 50:50 marital contract. Although they are not legally binding, they will usually be upheld as long as neither party was pressured into signing, you both received independent legal advice and there was full and frank disclosure.
What if during your relationship you start a new business either on your own or with someone else (your spouse or a third party) – can you protect that at the outset? Yes, a post-nuptial agreement will provide the protection you need for this situation.
These agreements may not be the most romantic thing to discuss with your partner, but the best time to agree what is fair is when you are happy. Given how common they are becoming, it’s worth starting the conversation early on.
To give you an example of what might otherwise happen on divorce. W owns a business and H wants the business to be considered an asset that should be shared. W needs to raise capital to offset the value of the business, but is unable to do so and some of the shares are transferred by the court to H. Now H owns part of the business in his own name and has a say in how it’s run, which he didn’t have when they were married.
Looking at this from a different angle, what if you are in partnership and your business partner’s ex-spouse is awarded shares in the business? This might not be a situation that you would have considered or agreed to in a business context, but it illustrates the importance of a suitable personal agreement being put in place between spouses
Another option would be to hold the business in a Trust. Trusts can provide effective protection from situations such as unsuccessful relationships, protection from paying excessive tax and also personal creditors if you have personal debt. If you have a genuine trust structure, then the assets of the trust may not be included as assets of the matrimonial pot in a divorce situation. However, the court will look really closely at the trust structure to ensure it is not a sham trust in place just to avoid paying money to your spouse.
As an entrepreneur working hard to grow your business, you are unlikely to have a guaranteed monthly salary. In the early stages, when the business needs reinvestment and time to grow, it is not uncommon to work without any income at all and it is easy to get into debt. You might turn to credit cards to smooth out the ups and downs of cash flow and provide some economic balance in your personal life. You believe you will be able to pay the card off next month, but you cannot, and a crisis begins. If you are unable to satisfy your creditors from your personal assets, they will look to your business.
Trusts provide some protections from creditor. There are lots of different forms of trusts but the most common one is a discretionary trust. For this type of trust the trustees have the discretion to decide who receives the benefits of the trust, when and to what extent. The beneficiaries therefore do not have a right to trust assets but rather a hope of receiving a benefit from the trust assets. The assets within a trust can include a business enterprise.
In practice the person setting up the trust will write a detailed letter of wishes to accompany the trust document so that trustees know how they intended the assets to be used. The Trustees will then give consideration to these wishes when deciding on distributions.
If you have personal creditors, then any asset in a trust from which you derive a benefit is unlikely to be able to be included in discussion with those creditors as it doesn’t belong to you, it belongs to the trust.
As the trust is its own legal entity and the beneficiaries won’t own any trust assets, you can enjoy the benefits of the trust assets without those assets being labelled as belonging to you.
This can be a useful tool in partnership. It’s important to remember that if you’re in a partnership then you’re not in control of your partner’s personal finances so this is something you may need to protect yourself from.
You may think that these considerations are not necessary for the young entrepreneur or someone who has just set up their business, but they are just as important for them. You don’t have to be a particular age for the unexpected to happen to you, what you do have to do is be prepared – for the sake of your business, employees, suppliers and customers and who are relying on you.
It is like when you get a mortgage and buy an insurance policy that will offset the value of the mortgage should something happen to you. When you set up your business, you should put in place protections, then review them as you and your business evolve. The good thing is that a lot of these tools can be a business expense. They are expenses that you should be budgeting for within your plans in the same way you do for employer’s liability insurance or building insurance.
You can find out more by watching Allard Bailey’s webinar session ‘Shield Your Business from Issues in your Personal Life’ below: