Restructuring a time-poor SME owner’s legal, financial and taxation advice has gone a long way to helping overcome financial illiteracy. Mark Story explains.
To Sydney-based SME owner Les Henry, 42, one of life’s biggest thrills was climbing to the summit of Egypt’s Mount Sinai by flashlight in time to watch the sun rise over the majestic rocky expanse below.
Similarly, after a fairly rapid ascent, the software and IT consultancy Henry had established five years earlier was also opening him up to blue sky.
But without the equivalent of a safety harness, Henry’s business had unwittingly become overexposed to significantly greater risks than he’d ever experienced leaning out from a craggy mountain face.
Due to strong “year-on-year” growth in trading activity, Henry had accumulated a respectable war chest within the business. But having been so busy working as a sole trader, he’d never stopped to question the risks associated with having so much money sitting within a “Propriety Limited” (Pty Ltd) business structure.
“I’d managed to straddle most money management issues up until this point, but I had neither the time nor the necessary tools to holistically assess my overall financial position,” Henry says.
WAKE-UP CALL
When Henry’s accountant saw that this business had amassed $200,000 in cash and term deposits, he sounded some alarm bells, and instructed Henry to pay a visit to professional planner Tony Clark.
“Having become a little smug about how well my business was doing, my accountant’s insistence that I seek immediate financial advice came as a rude and unexpected wake-up call,” says Henry.
“Up until this point, I didn’t think my wife and I had sufficient assets to even warrant paying for financial advice.”
Following a comprehensive review of Henry’s financial position, it became patently clear to Clark that unless there was some major restructuring, Henry would have a lingering drogue on his long-term wealth creation. Clark couldn’t understand why Henry, a married man with two primary school-aged kids, was continuing to ser- vice minimum mortgage payments on the $1.5 million family home in Sydney when there were clearly surplus funds lying idle elsewhere.
Clark also shared the accountant’s worries that Henry’s business had become an easy target for any future actions from would-be creditors.
“It never occurred to Les to identify who the assets of the business would belong to or who would incur future liabilities if anything happened to him,” says Clark.
He says that Henry, like many small business owners, had never really stopped to consider how much better off he’d be if his personal and business finances were integrated into one comprehensive overall strategy.
“Asset/income protection, and deployment of surplus cash where it can be most beneficial – namely into non-deductible debt – were the primary objectives,” Clark says.
BETTER DEPLOYMENT
In addition to the family home, and $200,000 cash held in the business, Henry and wife Nina had $130,000 and $90,000 respectively in personal super funds. The only other investments they owned – partly – were two residential properties that Les had bought jointly with a former work-mate before he met Nina. Given the downward pressure on housing prices, and with further interest rate hikes pending, Clark initially questioned whether the rental property strategy still made sense. On closer inspection he proved that the total returns would be underwhelming.
“Given how much Sydney’s residential property has grown in recent years, it was unrealistic to expect these two rental properties could deliver anywhere near the necessary rate of return to Les for the risks involved,” Clark says.
Based on Clark’s assessment that the two properties would now underperform in terms of both capital growth and income, he recommended that they be sold. Working with the accountant, it was agreed they’d be sold in two successive tax years, to spread the capital gains tax (CGT) liability accordingly.
Having experienced good capital appreciation, the rental properties looked fully valued. So it was time, adds Clark, to lock in the capital gain and “de-risk” the exposure associated with third-party ownership.
“A decision to keep the rental properties would have reduced the Henrys’ net wealth position,” says Clark.
“It would have also increased their risk, as both properties were geared, with the added complication of a third party co-owner who had different objectives.”
At Clark’s recommendation, the first rental property was sold for $365,000. Proceeds from the sale of the first house, plus $100,000 sitting as surplus cash in a business account, were used to pay down the outstanding $250,000 debt on the family home.
The other option was to take these funds and invest in a portfolio of diversified growth and defensive assets. But given the speed at which surplus cashflow was entering the business, Clark suggested that the acceleration of a wealth creation strategy should only resume once the remaining $100,000 in non-deductible debt was finally extinguished.
“Financial flexibility was paramount to Les and Nina, so by using an offset account, they’re able to reduce the interest charged on non-deductible debt by maintaining the highest possible balance at all times,” says Clark.
BALANCING ACT
Based on the cashflow the business is currently generating, Clark expects Henry to have cleared the non-deductible debt on the family home by late 2012. Once this has been achieved, the second property will go up for sale, and Henry’s share in the profits, expected to be around $100,000, will be dedicated to a flexible non-super investment strategy. Clark is also recommending surplus funds be invested into growth assets using a multi-manager wrap platform. Given that both Henry and Nina are still relatively young, Clark is also advocating a long-term growth strategy that will allow for more flexibility in the coming years.
