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Thursday, November 22, 2012

Can your self managed super fund invest in a private business ?

One advantage of having a self-managed super fund (SMSF) with plenty of cash is the investment flexibility that comes with having money available to invest. ..


The conventional way of investing in a private business is through shares in a company or units in a unit trust.
One advantage of having a self-managed super fund (SMSF) with plenty of cash is the investment flexibility that comes with having money available to invest.
Most SMSFs stick to traditional investments, but there are also less conventional investments, one example being buying an interest in a private business.
If you have encountered a business looking for investors you may well ask if you can use your SMSF to invest directly into the business or whether it needs to be through a commercial structure like a unit trust.
There are possible restrictions if there is a link between the investment and a member of the fund, so it is important to ensure that there is no relationship whatsoever between the business and the SMSF if this sort of investment is to be considered.
Risks
A SMSF can invest in private businesses in a number of ways – and it’s a strategy that some people can become very excited about. Unfortunately, when this happens, they can often overlook the risks to which they are exposing their retirement savings.
Investing in a private business can range from investing in the assets that comprise the business; or investing in a business structure like shares in a company or units in a unit trust that owns and operates the business.
As far as investing in assets used in a business, it’s possible a fund could invest in, say, shipping containers, that are leased to a business for storage purposes.
Acceptable
In such circumstances, a lease agreement would be put in place and an appropriate rental negotiated and paid. This type of arrangement could be acceptable under the super rules provided it was with an unrelated party.
The related party test is very broad and covers close family members and relatives as well as companies and unit trusts where a related person either controls or has significant influence. There is also a related party issue where the fund member is an employee of the business or a contractor who isn’t totally independent.
While taking a direct stake in business assets is one option, it is not that common, given it is like the SMSF entering into a partnership with the business. This can come with certain complications.
For example, in many businesses one of the main assets is goodwill; and there may also be some cash, trading stock, debtors, work-in-progress and some plant and equipment.
Values
These various assets and interests can be difficult to value and are likely to be constantly changing in many businesses.
A partner can also be subject to liabilities on a joint and several liability basis. This means partners can be responsible for any debts or liabilities incurred by other partners.
Many private businesses could therefore expose all the SMSFs assets to its legal liabilities.
While traditionally it has not been prudent for SMSF funds to carry on businesses, the Australian Taxation Office has recently conceded there is no express law prohibiting this.
Corporate trustee
If a SMSF is entertaining this idea, it should have a corporate trustee to limit some of this liability. The fund’s assets could still be exposed which is why approaching investing from this angle does not appeal to many SMSFs.
An alternative strategy that is popular for SMSF interested in the private business direct route is investing in the real estate from which the business is run – and then leasing this commercial property to the business.
Many SMSF like the idea if investing in a property where they know the business that will lease the property. Similarly many businesses like having a landlord that offers greater certainty when it comes to lease arrangements. Such investments can be done by a related party, although it must still measure up as an arm’s-length commercial arrangement.
Proportional share
The more conventional way of investing in a private business is through shares in a company or units in a unit trust. This way the fund still pays for a proportional share of the company or unit trust’s net tangible assets plus in the case of a business has some upside potential, a share of the goodwill in that business.
As far as any related party issues are concerned, where there is no related party a fund can buy shares or units in the business. If the company or unit trust is in some way related to the SMSF members, then the in-house asset rule can apply. These rules severely limit a SMSF from investing any more than 5 per cent of its resources in the investment with penalties if this is exceeded.
There are numerous SMSFs where very sound investments have been made in private businesses run through private companies and unit trusts.
Careful consideration
However, when comparing these investments to other alternatives, such as shares in a stockmarket-listed company, the risk-return analysis has to be carefully considered.
There are also cases where funds have lost considerable sums from private business investments. It is for this reason that it is important to obtain legal and financial advice before proceeding with any investments within a SMSF.

Source: Smart Investor

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