Your business is likely to represent a big part of your personal wealth. Getting your wealth together is a lifetime of work so the last thing you want to happen is to lose it because of some foolish decision or unexpected event.
In this recipe, we look at a number of the issues you should be aware of and plan for.
Protect your capital
Most investment books and gurus seem to stress that you should protect your capital at all costs.
They would argue this is vital because putting capital together is the hardest part of the wealth process and the weakest point if not followed carefully.
Consider the case of investing $100,000. If you invested it at 20% return but there was a high – say 30% – probability of losing the investment from (say) the company going bankrupt, you stand to make $20,000 in the first year but have an expected probability of losing ($100,000 * 30%) – $30,000 which means, on the balance of probabilities, you will go backwards on this investment by $10,000. That is a little vague as, in fact, you will either make $20,000 or lose $100,000. Either way, one slip and you have put some of your hard earned capital at considerable risk.
A similar thing happens on the stock market. You buy shares with a good dividend that pays you (say) 4% on your investment giving you $4,000 on your $100,000 investment. But, if the stock market declines by just 4% in the year, as it does regularly, and your share price follows suit, all your gain from the dividends is wiped out by the capital loss from the stock market decline.
You can always get a return on capital that you hold even if it is fairly small but you can never get a return on capital once it is lost.
Income tax is one of the biggest costs to your personal wealth. As a business owner you can be a lot better off than a person on a salary.
The following is an example in the Australian tax environment but it is likely to be similar in other countries.
A high income Australian salary earner probably pays tax of the order of 43-45% and has little control over the process because it is taken out by their employer and paid directly to the Tax Office.
If most of your money is made in a company structure, you will only pay about 30% of your income as company income tax. In fact it will normally be a fair bit less than that because you can probably also take deductions for your car, home office, professional library and other quite legitimate tax deductions.
So, when you read about someone in a bank or mining company who is paid $1,000,000 you might find a fair bit of satisfaction knowing that you only have to earn $600,000 to be as well off as they are! And, if you paid the same amount of tax as them, you would be grossing $1,800,000 to their $1,000,000 and taking home $1,350,000 while they get to take home $550,000! You are over twice as well off as the prominent banker is! Who is the smart cookie now!
If the money is in your company, you don’t actually get to take it home of course but you do get the benefit of its use.
Tax minimization starts before you even start your business.
You need early and professional advice on both setting up your business for tax minimization and, even more importantly, how to save on Capital Gains Tax when you finally exit and sell the business. If you have the wrong structure on exit, your tax can be huge. A little foresight and some good advice will help to minimize this. See Business Legal Structures
Legal tax minimization is therefore one of your most important tools to protect your wealth.
You should search for and find an accountant that gives you sound advice in this area. See Choosing professional advisors Tool for more on how to do this.
Unfortunate things can happen at any time. If you haven’t planned too well, the wheels can fall off your business and your life.
A little bit of forethought can help to minimize the fallout.
Young people and many men tend to think of themselves as invincible so the idea of taking out medical insurance seems just a waste of money to many.
If you have a severe medical crisis – a serious disease or a car accident for example – you would want the best medical care. Medical care is expensive. So at the very time you want the best for you or your family, you might not be able to afford it. If you have a reasonable private health insurance policy, most of your financial worries are covered.
When you are young, it is a bit of a line ball perhaps but, as you get older and/or have a family, it is really a matter of piece of mind that you are covered when the worse happens.
Life insurance is not going to be of much use to you personally if you are dead! But if you have started a family or have a dependent partner, you might consider it so that your family has a bit of a financial reserve, from the insurance, to cover your loss.
Personal Income Protection
You can buy insurance to protect your income if you have some event that prevents you working and earning an income.
This will guarantee you a certain income for most of the rest of your life if you need it.
It is cheapest when you are young by and large and steadily increases in cost as you age.
If your business flourishes, at some point, you will have enough wealth to stop taking it out as you can live comfortably on your income. from your wealth even if you can’t continue to work.
Key Person Insurance
Key Person insurance will pay money to the business if the insured person can’t work.
Given that you are going to be the key person in your own business, you might like to consider sufficient insurance to allow the business to continue operating long enough without you to manage an orderly exit sale if necessary.
Public Liability Insurance
If you run a business and someone is injured because of that business, you can be sued to compensate them for that injury. There is an entire industry of lawyers who chase this sort of work so, if there is a significant accident, it is more likely than not that you will be sued.
To protect yourself from this, firstly set up a Risk Management System (see Risk Management) that is primarily aimed at reducing the potential for an accident. It will also allow you to demonstrate that you took reasonable steps to reduce the risk of accidents and therefore may reduce the amount of compensation you have to pay.
Secondly, you should always consider taking out Public Liability insurance. In the event of an accident, your insurance company will provide you with professional advice and services to manage the problem and will also pay the compensation if you have acted properly but there has still been an accident.
This insurance is not expensive when you consider the potentially very large risk of financial loss you face without it.
If you employ contractors, you should consider making it a habit to check their insurance cover in case they cause an accident while working with you. You want to be sure they are covered and will share the costs. And remember to make a diary note to check their insurance is renewed each year so they remain covered.
Business Income Protection
You can insure your business against events that prevent it from earning an income. It might be a fire or burglary that destroys your accounts receivable records so you can’t collect your bills for example.
This insurance will give you an income while you get the company back on its feet again.
Power of Attorney and Living Will
If you are the only signatory to your bank accounts and something happens to you preventing you from signing pay cheques, your business can unravel very quickly.
You can set up various forms of Power of Attorney with a person(s) you trust so that they can take over signing decisions in the event you are incapacitated for some reason.
A simple bit of insurance but probably worth having.
In a similar vein, you might consider a Living Will aka Advanced Health Care Directive.
In the event you become unable to make decisions on your own health – perhaps through being in a coma or some mental problem – this Directive appoints someone you trust to guide your medical team according to your wishes.
Among other things if you are unable to be revived but are not yet dead, your entire business can be in limbo.
One of these Directives puts you in more control of your personal preferences for life while you are in a fit state to make those decisions.
Making a Will
It is probably a good idea to make a Will without fail as soon as you have any assets to speak of.
This will control how those assets are disbursed after your death.
Death can happen at any time so it is wise to be prepared.
Your Will is likely to change over time as you collect more wealth, move in and maybe out of relationships, have a family of your own and so on. It is probably therefore a good idea to review it (say) annually and an ideal time is on your birthday so you remember each year.
You might find that your lawyer will develop a two part document. One part being a formal Will that doesn’t change much from year to year unless your family status changes. It tends to be fairly precise in what you want to do. The other part may be a letter of direction to your executors that you can change yourself if you want each year. For example, the formal Will may say you want to leave $10,000 to charity and the letter of direction might specify on an annual basis which charities are to receive it and how much each gets. The directions letter can save the cost and inconvenience of redoing your Will every year as you tune it.
You can do your own will if you want using one of the many templates that are available and that might suffice while you are young and without many assets. Later in life it gets more complex and there can be a lot of inheritance tax planning so you should definitely get professional advice. (See Choosing professional advisors )
A Will and a Living Will are no use at all if people don’t know where they are so make sure you leave copies with your accountant and lawyer, family members and others as you see fit. It would also be wise to make sure your staff and family know who these people are so they can advise them of any emergency.
Consider that some 30 percent of marriages end in divorce and the rate of break-up in de facto relationships is probably higher. If this unfortunate situation might arise for you, you should be giving some thought to protecting your business from being broken up in a divorce settlement.
Many businesses and real estate properties each year are forced onto the market for sale because a divorcing couple haven’t given any forethought to how to handle a property split-up, if the relationship collapses, and a sale is the only option left to them.
Given the high, 30 percent, probability of losing half of what you have worked for, it seems a very sensible planning decision to have some sort of pre-nuptial agreement in place governing property distribution should this unhappy event come to pass. It probably seems a bit callous to be talking and agreeing on how to break-up even before you are hitched but that is going to be a lot less painful than watching your hard earned wealth go down the drain hole in the event of a fire sale of joint assets.
By definition, you need a pre-nuptial agreement before the nuptials. It may be too late after. You can see typical simple formats all over the web. Both parties should get separate legal advice to make sure their interests are protected.
These days, long term de facto relationships are becoming more common. It is entirely possible that your partner in a long term de facto relationship might qualify for a property settlement now and/or that the law may change in future to give them more rights. There has certainly been a trend to recognize the rights of gay partners for a while, as I write. Maybe, therefore, you should consider a pre nuptial agreement if your de facto relationship looks like becoming long term.
Keep in mind that some advice you get will tell you to put all the family assets in the name of a spouse or partner to protect you from losing everything if you are sued. If this is likely, you may need to give special consideration to the prenup to ensure it covers this situation.
In many countries, money can be placed in a retirement savings account or pension fund. In Australia, for example, this is referred to as Superannuation. Such accounts often get preferential tax treatment and are often safe from being reclaimed to pay your creditors if you go bankrupt. On the other hand, you are heavily regulated in what you can do with it and when you can spend it.
You should discuss retirement planning with your accountant or other professional to get advice best suited to you.
Intellectual property (IP) is the term given to intangible assets that have a value such as brand names, internet domain names, written materials, artwork and the like.
Depending on the nature of your business, these can have considerable value and add a lot to your wealth. Consider the value of the Coca Cola brand and the domain name google.com for example.
It therefore makes a lot of sense to take steps to protect this part of your wealth from theft and exploitation.
See the Intellectual Property Recipe for more on this topic.
Business Legal Structures
The best form of legal structure in which to place your business is something you should get legal advice on without doubt.
But it is important that you think about what you want from your structure so that, when you brief your legal advisor, you have a pretty good idea what you want.
Even the best legal people can only really create something that suits you best if you can tell them what you want.
For more on legal structures in general, see Business Legal Structures
Risk Management System
Everything a business does is risky to some extent. It’s one of the things business people have to live with on a continual basis and one of the things that separates business owners from employees.
You should develop a risk management plan for your own protection. In fact, the way health and safety law is going, you may be legally obliged to do so.
Not to do this means you put your wealth and possibly your freedom at risk.
See the Risk Management recipe for more information.
Protecting your wealth in review
In this recipe, we have touched on a range of issues that will impact adversely on your wealth if they go wrong.
Much of the adverse impact can be reduced if you pay attention to how you set up and run your business so that the problems never arise.
A lot of this stuff sounds like distractions when you are just itching to get going with your business. But a little bit of thought now can make life a lot easier in the future and protect you against the myriad of things that can go wrong and wipe out all you have worked for over the years.