Johnston Lawrence

Short Term Saving Does Not Give Long Term Gain - The value of having a trust when establishing a business

28 September 2008. by NZ Law Releases , tagged with Business Law | NZ LAW Releases | Trusts Estates and Wills

Mr & Mrs B approached their lawyer about purchasing a franchise business. This was a new branch of a franchise which was currently operating a number of outlets throughout New Zealand.

Establishing a business

Their lawyer looked over all the documentation for the proposed purchase, which included a franchise agreement, a sub-lease of the premises and a number of the other documents the clients had been provided with.

After considering the documents and financial factors, Mr & Mrs B’s lawyer had some concerns for their future success in the business, the potential returns and its profitability.

Their lawyer then sent Mr & Mrs B off to see an accountant to review all the financial information and to produce draft cash flow and profit projections. Although these were not particularly promising, Mr & Mrs B wanted to work for themselves, rather than earn the same amounts they were currently being paid in their salaried positions.

A company was incorporated, a franchise agreement and sub-lease signed, and Mr & Mrs B opened their business.

During this process, their lawyer had advised Mr & Mrs B of the advantages of forming a family trust, or trusts, primarily to protect the family home which had considerable cash equity but also to take advantage of the potential for income tax savings through the family trust/s, being a shareholder of the company.

Mr & Mrs B did not adopt their lawyer’s recommendations due to cost considerations.

When things go wrong

About two years later, Mr & Mrs B returned to their lawyer to see what could be done to sort out the financial mess they were now facing. There were extensive rental arrears, numerous unpaid creditors and they wanted to terminate the franchise agreement. Unfortunately there was little their lawyer could do to save the day apart from directing them to a liquidation specialist.

On the surface things looked promising as Mr & Mrs B had not increased their bank debt to try to save the business, and there was still considerable equity in their home.

Unfortunately Mr & Mrs B had signed numerous personal guarantees in respect of the lease, and the payment of franchise fees and suppliers.

The inevitable occurred; the house was sold at a fire sale price, the equity was gobbled up by the personal guarantees and Mr & Mrs B’s marriage started to fall apart under the stresses and strains imposed by their financial position.

The costs quoted to Mr & Mrs B to form the family trust/s, transfer the property to the trusts, re-document the mortgages and complete all the associated documentation in respect of forming new trusts, was less than 1% of the equity in the family home.

When establishing a business, it makes good sense to protect your family’s assets. Short term saving of the costs to set up a trust or trusts, does not necessarily give long term gain. If you are considering business opportunities, do talk with us in the early stages to ensure your family’s assets are protected.

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