Fencing Off Your IP: Asset Protection – Part 2
This is the second of a two part series about the ways in which different ownership structures can be used to protect IP Assets. In Part 1, we explained how separating ownership and operations is crucial to protecting assets in the case of a business failure.
Many ways to skin a cat
In this part, we look at a few of the more common ways in which this is usually achieved. As in Part 1, we do this by using the example of the husband and wife entrepreneurs who manufacture a new type of pool fence. They have personal assets (equity in a house, a small share portfolio and a couple of family cars), while the business has expensive equipment required for the manufacture of the pool fence (a custom mould), along with different types of intellectual property: trade marks, registered designs and a patent application.
Warning! As with all of the content on this website, the information in this post is of a general nature. Specific legal advice should be sought before establishing a new ownership structure. In particular, extreme care needs to be taken when re-structuring assets of established businesses, as these can trigger significant and unintended capital gains tax and stamp duty consequences
The basic strategy: A single limited liability company
The threat of losing one’s home and other assets is generally well understood amongst the business community. Accordingly, as shown in Figure 1 below, many business owners choose to use limited liability companies to address this risk.
As you can see, the personal assets are held by the entrepreneurs, while their business assets are held by the limited liability company.
- If the business is sued, in most cases the entrepreneurs would not lose their family home, or other personal assets such as shares and cars etc.* In other words, only the company’s assets would be at risk.
- Third party investors are more likely to be comfortable with the idea of investing in the business by taking shares in the trading company than becoming ‘partners’ in an unincorporated venture.
- This is still a relatively simple structure. The company does need to submit an annual tax return (one that is more complicated than a personal return) and it does need to notify ASIC of certain changes etc, but this level of added complexity is easily manageable.
* This statement assumes a number of things. For example, it assumes that the entrepreneurs haven’t personally guaranteed loans from banks to the company, and it’s not the bank that is suing for the company’s failure to repay the loan. It assumes that there are no unpaid amounts on the shares issued to the entrepreneurs, or that this amount is very small. Finally, it also assumes that the entrepreneurs haven’t become personally liable for the company’s debts by trading while insolvent.
- Although the entrepreneurs probably wouldn’t lose their house, they could potentially lose control of their key economic assets: their intellectual property and their equipment if their business were to suffer a catastrophic event.
- The entrepreneurs have very little flexibility in terms of income tax planning.
- If the company sells any of the key assets in the future, it wouldn’t have the benefit of the 50% capital gains tax concession that is available to individuals.
The basic strategy with a twist
As depicted in Figure 2, it is possible to separate the ownership from the operations if the entrepreneurs simply hold the assets in their own name (as in Scenario 1) but license those assets to their trading company. The idea is that the trading company is conducting all operations, making it difficult for the entrepreneurs to be sued in their own capacity.
- A reasonable level of asset protection is created (although see below).
- This structure has a reasonably low overhead in a regulatory and reporting sense (ASIC, ATO etc).
- Tax planning flexibility is minimal.
- Without good processes and solid licensing agreements, intellectual property can inadvertently arise in the trading company, and this IP would be at risk if the company were sued, or were to become insolvent.
- Directors of companies (such as the entrepreneurs in this case) can occasionally be held personally liable for their actions as directors. As all of the assets are held in their personal names, the asset protection afforded by this structure is not perfect.
- Arms length investors would usually be unwilling to invest in the trading company when it does not own any of the key economic assets.
Separate holding and trading companies
In Figure 3, there are two separate companies: one to hold the assets, and one to do the trading. The holding company licenses the right to use the assets to the trading company.
- The family home will be safe (subject to the issue of personal guarantees etc).
- The key intellectual property assets and income-producing equipment will be safe.
- Arms length investors should be happy to take shares in the holding company.
- Setting up and running this kind of structure is reasonably expensive.
- There is still little flexibility in terms of tax minimisation.
- In addition to their personal tax returns, the entrepreneurs would be responsible for the tax returns etc for two companies each year.
Vanilla isn’t the only flavour
While the structures outlined in this post offer many advantages, they are somewhat limited in a number of respects (tax planning in particular). We’re happy to work with our clients and their tax advisors to set up methods that are more tax effective.