Concepts brought into existence hundreds of years ago still influence, if not determine, how a business should be structured. The steps that you should take to upgrade your business were first taken by others hundreds of years ago.
The Dutch East India Company was established in 1602, for the purpose of funding colonial activities in Asia. The Dutch East India company is the predecessor of all companies. From these early companies came the idea of a legal entities which could separate business risk, from personal assets. If you operate a business today it is almost inconceivable that you would operate without the legal protection of a company. Although governments from time to time attempt to water down the protection offered by companies, the limited liability company is likely to be a provider of asset protection to business people, for a long time to come.
An even older business structure is a trust. Even before limited liability companies came into existence trusts were used by the wealthy to separate ownership and control. The laws that brought into existence the concept of a trust were made at about the time of the Crusades in the 12th and 13th centuries.
During the crusades land owners would leave their land in the possession of a caretaker, while they were away. When the crusader returned many caretakers refused to hand back the land. The law at the time was inflexible and did not support the original land owner. The common law courts decided that the land belonged to the person who was trusted with the care of that land (the trustee). Strangely there was no obligation upon the trustee to honour the original promise by returning the land to the original owner. It was however recognized that this situation was unfair. The King’s court which was separate from the common law courts had the power to make decisions based on conscience. It was decided that the legal owner i.e. the caretaker trustee, held the land not for their own benefit but for the benefit of the original owner. This was what was need to bring into existence the law of trusts. It was settled that the legal owner of an asset may hold that asset for the benefit of another person.
These trusts and companies are the same structures that we use in business today.
A company is a separate legal person. It has the right to enter into contracts. It can sue and, be sued. If Bob operates a company and Bob’s company is noted as the owner of the business then Bob’s customers and clients are not dealing with Bob but instead they deal with Bob’s company. Bob is no more than an employee. A customer who is damaged by the activities of the business will have a claim against Bob’s company but not against Bob. This is how a corporate owner protects its members (shareholders) from claims which result from the activities of the business.
But what about attack from outside the business? The company shares are a valuable asset, as they entitle the shareholder to the capital and income of the company. It might be tempting for a creditor to attack that asset. An individual shareholder may be exposed by her position as director of a company, as a result of divorce, negligence or any act done in her capacity as an individual. The company can of course only protect shareholders from the actions of the company, not from their own personal actions. It is best therefore that an individual not hold shares, or for that matter any valuable asset unless there is good reason. The family home is for tax reasons an exception to this rule. In relation to the family home entirely different strategies must be employed.
Individuals protect their assets by declaring that although they have the legal ownership of an asset they do not have the equitable ownership of that asset. In other words on their conscience and by a declaration, in a trust deed, it is said that the asset is held for others. In the case of family trusts the legal owner of the asset holds the benefit of that asset for their children and other family members. This is done using the same concept that 800 years ago, required the legal owner of land (the caretaker) to hold that land for the benefit of the returning crusader.
Obviously over time lawyers have become more innovative in the way that trusts and companies are combined and structured . Trustees and companies can enter into intricate agreements and relationships with each other however, the fundamental rules continue to apply.
These structures remain at the foundation of asset protection and the concepts which allow these structures to be so effective are underpinned by hundreds of years of law. Previously only the rich could put in place, sophisticated corporate and trust structures. Now these structures are inexpensive and are common place for every day business people. If you plan to upgrade your business then it would be a good idea to start by ensuring that you are correctly structured from a legal position.