You’ve worked hard. Your company has grown. It’s profitable. Retained earnings are growing, which means the company has accumulated profits. Future growth is expected. The bank is happy with the company’s financial statements. Everything looks great. Congratulations, you’re all set!
But… are you REALLY all set?
“Stuff” happens. What if something goes wrong in the company? A sizeable project fails. A significant customer goes bankrupt and cannot pay their bills – losses result. The company is sued for a substantial amount. These are only some of the scenarios that could result in the hard-earned retained earnings of your company disappearing. What can you do to protect all your hard work and accumulated earnings of the company?
There are initiatives that you can proactively take now to protect against future threats to the assets and retained earnings of your company. In this three-part series, Lott and Company will discuss opportunities that are available to protect your corporate assets, including the following structures:
- Part One – Shareholder loan
- Part Two – Holding company
- Part Three – Family Trust
Part One – Shareholder Loan Structure
Protecting Corporate Assets
A shareholder loan structure is the simplest and easiest structure to implement and administer. To protect the company’s assets from potential creditors, simply extract the retained earnings from the company by declaring dividends. Should a claim be made, creditors cannot access these funds after the dividends were declared and paid.
However, if your company is growing and all of the cash is tied up in receivables, inventory, work in process and equipment – there is no extra cash to implement this strategy.
But a lack of excess cash does not prevent a shareholder loan strategy from working. The dividend can be paid with a promissory note. You can then register security against the company to protect this promissory note. This ensures that, should a financial crisis arise in the future, you will be paid before any unsecured creditors of the company.
This is a straightforward structure to implement, but there are some consequences to consider. The biggest downside is personal tax. Ineligible dividends can be taxed at a rate as high as 48% depending on how much personal income you have in the year that the dividend is declared and paid. This doesn’t leave a lot of after-tax dollars to invest and is a particular problem when there is no cash in the company to pay the dividend.
These issues can be dealt with by using a holding company structure which we will discuss in the upcoming part two of our Lott & Company three-part “Protecting Corporate Assets” series.