Business Management Articles
Starting a Business? Start First by Protecting Yourself!
Phil Chopp
BDO Dunwoody LLP
November 2004, Hamilton Chamber of Commerce, Panorama Magazine
“I invested $100,000 in this company, and now I stand to lose all of that – and maybe even my house!”
Ron was justifiably upset about the frightening financial circumstances he found himself in – barely two years after proudly launching his own business. He came to us desperate to know what he could do to stem the bleeding – and to prevent the loss of his house.
While we were able to provide some assistance through an insolvency proceeding, if Ron had come to us even a few months earlier, the outcome would have been far better for him. If you are launching a new venture, you must be aware of your business and personal risks – and put into place certain safeguards to protect your investment and to limit those risks.
Like Ron, many people begin new business ventures without fully appreciating the risks. For example, it’s commonly believed that if you run your business through a corporation, you will not have personal exposure should the company fail.
Here’s the real deal.
Corporations can protect personal assets of the shareholder; corporate assets are always at risk to creditors. Generally, shareholders of the business are at risk only to the extent of their investment in the corporation – except where the shareholder becomes a director of the corporation or provides personal guarantees for the corporation’s debts.
It’s common practice for owners and their family members to act as directors of the incorporated business. As a director, however, you could potentially be liable for obligations under more than 100 federal and provincial statutes, including unpaid GST, PST, payroll deductions, employee wages and vacation pay and environmental liabilities.
It’s also common practice for lending institutions to require personal guarantees from owners for corporate loans or lines of credit. But when you provide a personal guarantee, as a shareholder in the corporation, you are liable for debts if there are insufficient corporate assets to satisfy the obligation.
Having said all of this, how do you protect yourself? Fortunately, there are a number of preventative measures that you can take as a shareholder and director of a corporation.
Incorporate
Incorporation may not eliminate all risks, but it certainly reduces many. By incorporating your business, you restrict the access of creditors to the unsecured assets of the corporation thereby protecting your personal assets.
Split the corporation in two
Set up two corporations: one (the holding company) to hold and lease assets such as real estate and equipment and the other (the operating company) to carry on the business using the leased assets. In the event of financial problems in the operating company, the assets of the holding company would be protected.
Limit: one director/family
If two spouses are corporate shareholders, only one of you should be a director and your joint assets should be structured such that the “director” spouse has little or no assets. This would protect the individual’s assets in the event of future claims. This structuring of personal assets should be completed in advance of becoming a director.
Invest in the business with secured debt
"Secured debt" takes precedence over unsecured debt. Shareholders' investment should be comprised of as much secured debt – and as little equity—as possible. The security for the debt can be over specific assets or be a general security agreement (gsa) covering all assets. Should the corporation face financial problems in the future, the owner’s secured investment would rank ahead of claims by unsecured creditors.
Limit personal guarantees
While many lenders insist on having personal guarantees, where possible, avoid unlimited guarantees or joint and several guarantees, which increase your risk exposure. Try to negotiate specified financial limits or periods of time with lenders.
Track obligations for government remittances
Monitor your obligations for government remittances, including GST, PST and withholding taxes to ensure that you always have sufficient funds to meet these obligations.
Prepare a shareholders’ agreement
If the corporation has more than one shareholder, develop a shareholders’ agreement that includes all shareholders – including those with minority shares. This document outlines the rights and obligations of the shareholders in the event of disability, bankruptcy, insolvency or a requirement for additional financing.
One final suggestion: get thee to an accountant and a lawyer. The right accounting and legal advice at the beginning of your new business life could save your business and personal assets in the future.
Phil Chopp, CA, is a partner of BDO Dunwoody LLP. BDO is one of Canada's leading accounting and advisory firms, which helps entrepreneurs and family businesses succeed. If you have questions about this article, contact Phil in the Hamilton office at 905-526-2077 or pchopp@bdo.ca.
