Rightways: Yap Ming Hui

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Thursday, 3 November 2022

How to protect your sole proprietorship

How to protect your sole proprietorship ...

While your business may be thriving under your sole proprietorship, it is important to realise the consequences of having a business ownership tied to you individually, and how it may impact your family in the eventuality of your death.

THERE are many ways in which middle-income Malaysians make their money; the most common is through a sole proprietorship business, which forms a major part of the business owner’s overall wealth value.

There are many upsides to owning a sole proprietorship – it is fairly easy to set up, the startup costs are low, you have full control over the business as you’re the sole boss and, of course, the main draw is that you keep all the profits you make.

However, a sole proprietorship also has its disadvantages. One of the major disadvantages is that there is no distinction between your private assets and business assets.

As such, there is unlimited liability for debts, which has a potential to eat into your personal wealth should you not take measures to manage your business well.

An aspect commonly overlooked is the need to protect or preserve the business value and continuity should something happen to the owner.

Therefore, while setting up a business may be a positive step to take to help bolster one’s income, there’s also the stark reality every sole proprietor would eventually face – their business will also be terminated should any unforeseen circumstances happen to the owner.

This can be especially daunting for the families of the sole proprietor, who may face immense difficulty in managing their finance and preventing the families’ wealth from being affected after the death.

The case of Leong

Let’s take the example of Leong, a sole proprietor of a successful accounting practice in Puchong with 15 non-professional staff.

Leong’s business was doing so well that even with overhead costs of RM80,000 a month, he could easily draw RM45,000 per month from his practice.

Due to his lucrative business, Leong’s wife stopped working to spend more quality time with their children. One day, Leong met a fatal road accident and passed away. And with his sudden death, came a financial crisis to his family.

Clients who were once close acquaintances of Leong’s practice switched to competitors who offered the same services. Leong’s wife, not a qualified accountant, was unable to pick up her late husband’s business to continue offering these services.

Eventually, the business was forced to wind down as the dwindling income was not able to pay off the company’s overheads.

Since Leong was the sole breadwinner for the family, having no business income meant having no income for the family to survive off. His personal savings was only able to last the family 11 more months without any further influx of income.

As grim as this recollection sounds, it actually happens a lot more often than one might guess.

The question is – how do we avoid such situations for ourselves and our families? What could Leong have done to avoid this financial tragedy befalling his family?

First, let’s see some of the options that are available to Leong’s wife in such a circumstance.

> Liquidation of business by estate administrator.

Unless authorised by the will or court order, the administrator or executor must wind up and liquidate the business as soon as possible. Forced liquidation usually results in severe loss of business value, sometimes ranging as much as 40% to 90%.

> The estate administrator or executor continues the business until it can be sold as going concern.

In this alternative, the sole proprietor’s will gives the power to the administrator or executor to continue the business and exempt him from personal liabilities for the appropriate actions taken during this period.

However, the administrator or executor may still be liable for any losses caused by his or her negligence or imprudence.

Inexperienced administrator

The risk here is that, the administrator or executor may not be experienced or familiar enough to run the business operation.

Secondly, after settling the outstanding estate liabilities, administration expense and taxes, the administrator or executor may not have sufficient working capital to continue the business.

> The heirs inherit the business through a will.

In the sole proprietor’s will, the business can be transferred to the heirs as a gift. However, the heirs may not have sufficient knowledge or ability to run the business profitably.

If they are not successful in running the business, there’s the risk of dissipating their other estate inheritance in order to save the business. As such, the business gift may turn out to be a liability rather than an asset for the heirs.

> Sale of the business through as agreement prior to the death of the sole proprietor.

Before his death, the sole proprietor may offer the sale of his business to his employee or an interested outsider.

Under this alternative, the potential buyer enters into a contractual agreement with the sole proprietor so that the sole proprietor binds his estate to sell and the buyer to buy the business at an agreed price.

Now let’s take a look at some actions that sole proprietors can do while they are living to ensure that their surviving family members are not put into a tough position financially.

> Get a proper business valuation assessment as part of your estate planning.

As sole proprietorship is the trickiest to sell, it is important to have a licensed financial planner to help assess the business value.

He or she would be able to highlight the probable shrinkage in its value under different circumstances, and prevent the sole proprietor from overvaluing their business and thus under preparing the cashflow needed upon death.

Power to executor

> Give the executor of your will the decision-making power to continue or sell the business.

Without this instruction, the executor is bound by law to protect the assets in the estate, and thus may default to winding up the business as soon as possible, which could result in losses.

If the heirs are interested to continue the business, owners of the sole proprietorship may want to instruct the executor to transfer the business to them.

> Seek out a buy-sell agreement with friends or network in the field.

For some professional practices like accountant, doctors, land surveyors, architects, consulting engineers and others, a good practice would be for the sole proprietor to reach out to friends or network in the same field to enter into a buy-sell agreement as an alternative.

Such an agreement will ensure that the surviving professional will purchase over the practices from the deceased’s estate.

An agreement like this would not only help one, but both sole proprietors to ensure the continuity of the business in the event of one of the owner’s demise.

> Identify key employees who can succeed the business.

Depending on the nature of your business, you may want to invest some effort into identifying a potential successor and prepare them to take over the business one day.

Involve any prospective successor in the day-to-day operations to give him or her more experience. You could also consider entering into a buy-sell agreement with the potential successor to buy your business in the event of your death.

> Protect your family with life insurance.

This solution acts as a buffer to provide a safety net to your family. Protecting your family with life insurance while you’re still alive could help bolster losses incurred from a forced wind up of the business.

Forced liquidation

In some cases, the forced liquidation could result in liabilities in excess, of which the life insurance coverage will be able to compensate the business value loss.

In the case that your business does not go through a force winding up, the life insurance claim proceeds will buy your family time to transition through settling your estate, learning the ropes of your business, and/or provide your family accessible working capital during the transition period of settling your estate.

In the case of entering a buy-sell agreement with an interested buyer, he or she can consider purchasing life insurance on the life of the sole proprietor.

This may sound crude and calculated but when the time comes, it can provide additional funds needed for the purchase of the business.

If you are a sole proprietor, I invite you to evaluate your risks while things are going well with your business. The best way to do this is to employ the expertise of a licensed financial planner.

The licensed financial planner would be able to help identify the pros and cons of each alternative to your business and incorporate your intended wishes into your comprehensive financial planning.

Yap Ming Hui is a licensed financial planner. The views expressed here are the writer’s own. Any reliance you place on the information shared is therefore strictly at your own risk.

The Star - StarBiz By YAP MING HUI

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Related

How to Protect Assets in a Sole Proprietorship

https://smallbusiness.chron.com/protect-assets-sole-proprietorship-10492.html

Generating sustainable retirement income

Young adults in developed countries rent, we buy houses for good

Saturday, 9 January 2021

Generating sustainable retirement income

Many Malaysian are EPF contributors and have FDs as well. "You will never understand how bad the feeling is when you have to break your fixed deposit to cover your living expenses."

ONE of the top financial concerns of retirees is running out of money.

Whether you were an executive earning a reasonable income, or if you are making top dollars as a businessman, the fear is still valid.

For example, Tommy, who left the working world soon after selling his factory to a European multinational corporation. Tommy shared during one of our meetings that he was golfing every week and globe trotting almost every other month.

However, there was a problem that greatly bothered him. He found that he was dipping into his fixed deposit every now and then just to maintain his interesting lifestyle.

“Yap, you will never understand how bad the feeling is when you have to break your fixed deposit to cover your living expenses, ” he said.Combing through all of his finances, we discovered that Tommy’s lackadaisical attitude was to be blamed. He has not been paying enough attention to invest and generate income from the RM12mil nest egg that he had painstakingly accumulated. His investment portfolio was a mess.

Over the years, he invested in a few properties but never really bothered to oversee them. When tenants left, he didn’t make an effort to secure new tenants. In fact, some properties were even sitting vacant and idle. His excuse? He was too busy running the business.

Yap Ming HuiYap Ming Hui

Tommy has also invested in some shares and unit trusts but he seldom monitors and reviews their performances. Imagine his surprise when he went looking for some extra cash but discovered that most of the investments were not making money. Prior to meeting me, he couldn’t decide whether to sell or to keep those underperforming investments.

Consequently, the bulk of Tommy’s wealth is in fixed deposit. The trouble is the interest income from fixed deposit barely covers the impact of inflation. As such, if Tommy continues to spend on his interest income, he will risk having the principal depleted.

Asset rich, income poor

Tommy’s problem is a typical case of “Asset Rich, Income Poor.” His situation is definitely not unique. In fact, I find most self-made millionaires or business owners, typically strong at creating wealth from their business or professional career, but poor at generating income and gain from the created wealth.

For one, all the time spent ensuring their businesses succeed also takes them away from making sure that the wealth created is optimised.Let’s examine Tommy’s assets and see how it measures up (see chart).

The RM6mil in fixed deposit generate approximately 2% interest income. However, notice that the 2% of interest is not sufficient to offset the 4% inflation provision. As a result, there is negative net income coming from Tommy’s fixed deposit asset.

Tommy’s properties are worth RM3mil and only generates RM50,000 in rental income per annum. Nevertheless, this can be considered a net income because inflation will be hedged by capital appreciation (at least 4% per annum) of the properties.

The RM1mil in shares gives a total return of 5%. Factoring 4% inflation, the actual income received from share investment is RM10,000.

Unfortunately, the RM2mil unit trust investments didn’t offer any returns. After inflation provision, his unit trust investment has a net income of RM80,000.

The reality is if nothing is done now, Tommy’s wealth will continue to shrink by RM140,000 a year once inflation is factored to the equation. How does this play out for Tommy? The fact that he needs RM360,000 a year to maintain his current lifestyle will not augur well for him.

So, how can you prevent from ending up in Tommy’s situation?

The optimisation measures

> Remember to review the performance of each of your investment asset classes. In order to generate more income and gains, be proactive in getting rid of poor quality and poor performing investments. Look at each investment and ask yourself, should you keep it or should you sell?

> Consider moving fixed deposit into higher return investment.

Any gains from your fixed deposit would probably be eroded by inflation, especially given the current low interest, which will probably persist for quite some time. After calculating and providing for your emergency fund cash reserves, the balance of your fixed deposit should be invested into other investments that can generate higher return and income to hedge against inflation.

> Diversify the source of retirement income

Even if one investment asset can give you a good income and hedge against inflation, it does not mean that you must bet all or the majority of your wealth in it. For example, property investing. Some investors have found success in it. They were able to generate good capital appreciation and rental income.

As a result, they put a majority, if not all, of their wealth into properties. It may sound logical at first but rental income is not sustainable in the long run. It is subjected to changes, some of which cannot be controlled. Therefore, the best practice is still to diversify your retirement income across different asset classes, like share dividends and capital gains, unit trust gains, bond investment gains, retirement income products and others, so that it is not badly affected by any one impact.

The ability to grow your wealth during retirement years is important. Just because you have stopped working, it does not mean your money should stop working too. The idea behind wealth optimisation is to ensure that you can upkeep your retirement lifestyle and protect your wealth from inflation.

Ideally, one should get a plan done a few years prior to retirement to see how your retirement income would play out. After all, you wouldn’t want to have any unpleasant surprise, like in Tommy’s case. When you have time on your side, you can improve your investing skills and adjust your retirement plan accordingly while still in your active income earning years.

Yap Ming Hui is a licensed financial planner. The views expressed here are the author’s. Any reliance you place on the information https://www.thestar.com.my/business/business-news/2021/01/09/generating-sustainable-retirement-incomeshared is therefore strictly at your own risk.

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Sunday, 25 June 2017

Money game scourge

Easier option: Poor experience with regulated investment product providers may be the reason for investors to go for ‘alternative’

Poor wealth management experiences fuel money games

OVER the past 2 months, it was virtually impossible to pick up any newspaper and not read reports about the money game phenomenon that has taken the media by storm.

It is as if the Pandora’s Box had been suddenly flung open by the exposé of JJPTR, leading to other similar schemes coming to light.

The victim profile ranges from white-collared professionals and savvy businessmen to senior citizens and housewives. It would appear as if just about anyone from different walks of life could be susceptible to these money schemes.

It is easy for observers and bystanders to pin the blame on the investors for getting themselves in a sticky situation. After all, if we apply the caveat emptor (buyer beware) principle to other types of goods and services, the investors should have clearly known the risks of subscribing to these money games and therefore should have been aware of the possibility of losing their investments.

So, what caused groups of people to lose their common sense when it comes to money games?

Scams come in many shapes, sizes and forms but look closely and you will see that they all have many things in common in terms of the modus operandi and the people they seem to attract. From JJPTR and MBI International right at our doorstep to China’s Nanning investment scheme and the most notorious Ponzi scheme of all times – the Madoff scandal, all these scams preyed on innate human weaknesses and appealed to investors’ desire to grow their wealth.

Many would be quick to label these investors as greedy or gullible, but I beg to differ. I see nothing wrong with wanting to achieve financial freedom and get higher investment returns. The people who invested and lost in these scams are not multi-millionaires with ample financial resources. They are average Malaysians who have worked hard and saved their money for a rainy day, only to see their nest egg disappear into thin air. What drove them to place the precious results of their blood, sweat and tears into unregulated investment schemes?

I am convinced that the reason stems from the investors’ poor experience with regulated investment product providers.

The so-called ‘push’ factor

There is a mismatch of what consumers need and what financial institutions are trying to sell. Consumers want guidance on how to use regulated investments as a means to grow their wealth with high certainty and achieve financial freedom.

The general public sees banks as an easy, accessible channel to obtain advice on personal finance and investment matters via wealth management services. There is no issue with legitimacy as the array of financial products and services available through banks are duly approved by the regulatory authorities.

The problem arises when investors are not getting what they need, which is advisory support, from their current wealth management providers. More often than not, investors feel overwhelmed by the choices available in the market. Worse still, investors do not know what action to take when their investments lose money. It is not uncommon to find that the wealth management providers are very attentive and proactive in recommending options; but once the sales is concluded, the investor is basically left to his or her own devices.

As a result of the lack of hand-holding or after-sales service, some investors may find that rather than growing money, they end up losing 20%-30% of their capital. The sheer irony of it is that because of the experience of losing money, they now perceive regulated investments as highly volatile and uncertain, and ultimately lose faith. I have personally encountered clients who harbour such misgivings about unit trusts, that they would bluntly tell me right from the initial meeting, not to propose such options to them.

I realised then the extent to which poor experiences with wealth management providers can lead to misplaced biases against certain investment vehicles even though investors could benefit from the right ones. When disillusioned investors turn their heads elsewhere, this is when they discover “alternative” investment options. And many end up falling for money games because they are sold on the idea of fixed return investments perceived to be low risk, coupled with the promise of better returns.

In this instance, the “push” factor, i.e. the unmet financial needs of consumers, which contributed to investors subscribing to shady schemes, has equal bearing to the “pull” factor (attraction) of these money scams.

“I am like any other man. All I do is supply a demand.” – Al Capone, American mobster

As with most goods and services that are detrimental to our well-being (e.g. junk food, cigarettes, gambling, etc), it is consumers’ demand for them that drives their industry and makes them thrive. Without customers, these shady businesses would naturally die off.

The ability of the money games to proliferate boils down to the “smart” business acumen of the operators to “fill the gap” so to speak. By offering an alternative investment scheme at a time when the market is slow and when many investors are experiencing losses, these money games are seen as a sudden golden ticket towards becoming rich. However, as we have seen, the golden ticket eventually loses its shine and the investors are left holding nothing but a worthless scrap of paper.

Therefore, there would be fewer victims of money games if the wealth management industry as a whole were to step up and reinvent themselves into a genuine one-stop financial centre to help their clients address all financial and investment issues at various points of their lives.

When the grass on one side is always greener, the rest will not matter

In order to ensure that they are seen by clients as the “go-to” person for all financial and investment related concerns, wealth management providers will need to exceed expectations and to a certain degree, over-deliver on their current role.

Wealth managers could assist clients to evaluate various investment proposals to determine its suitability and guide clients to use regulated investment vehicles to invest in various asset classes such as equities, bonds, REITs and foreign investments to grow their money effectively. They could also play the role of a financial bodyguard to help investors fend off scams and illegitimate investments.

In an ideal world, wealth managers will set aside sufficient time and effort to understand the client’s financial position in a holistic manner. They will prepare a tailored and dynamic plan with milestones and checkpoints to help monitor and review progress.

To my peers in the wealth management industry, I would say, cut the lip service and let’s get serious about managing and growing wealth for our clients.

When more and more investors realise that they are able to count on their wealth management providers for all the required support they need to achieve their financial end game, then money games will no longer have room to take root.

Money & You Yap Ming Hui

Yap Ming Hui (ymh@whitman.com.my) is a bestselling author, TV personality, columnist, coach and host of Yap’s Money Live Show online. He feels that the financial world is getting too complicated for everyone, and initiated a weekly online show to address the issues.For more information, please visit his website at www.whitman.com.my

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