No one starts a business with a plan for it to fail. Unfortunately, business failure is a reality. A recent Industry Canada study concluded that 30 percent of small businesses won’t survive longer than two years, and only half make it to five years.
Here are the top 5 things business owners can do to protect themselves when their business fails:
1. Do not make family members directors in the company
The directors of a company are personally responsible for unpaid HST, employee source deductions, wages and vacation pay. Many struggling businesses pay their employees and suppliers ahead of the government. If the business fails, the directors are personally responsible for the outstanding HST and source deductions. Too often, family members who are not involved in the business are named as a director, exposing them to personal liability for some of the debts of the business.
2. Take security for money they put into a company
Most business owners have to put their own money into their business. Unfortunately, most owners don’t take security for the money advanced. If banks take security for their loans to the company, why shouldn’t the owner? If a company is wound up or goes bankrupt, the secured creditors are paid ahead of unsecured creditors (e.g. suppliers). By taking security for the money an owner puts into a business, the owner may be able to recover some of the money they invested. The owner should consult a lawyer to ensure that security is properly documented and registered.
3. Do not personally guarantee debts of the company
Personally guaranteeing a debt makes it your own debt. If the company fails, then anyone who personally guaranteed the company’s debt will have to pay, even if the company goes bankrupt. Typically, banks will not lend money without a personal guarantee, but other lenders, landlords and suppliers may not require a personal guarantee. Even if a supplier or landlord asks for the guarantee, the owner can often negotiate this out of the deal.
4. Consider keeping assets out of their name
If the business fails and the owner is personally responsible for any of the debts (as a director or through a personal guarantee), a personal bankruptcy may be the end result. Creditors can only go after the assets that belong to the debtor. If personal assets are in the name of the business owner’s spouse or another family member, then creditors cannot seize those assets and they would be protected in a personal bankruptcy. There are strict rules about transferring assets when a person is insolvent, and there may be family law issues to consider if assets are in a spouse’s name. These issues should be discussed with a lawyer.
5. Maintain good records of the money put into the business
An Allowable Business Investment Loss (ABIL) is available for people who have lost money in a Canadian Controlled Private Corporation. An ABIL allows the person who lost money in the business to write-off a portion of the money lost against personal income, thereby reducing the amount of personal income taxes they pay. In order to be able to claim an ABIL, the business owner needs to be able to prove to Canada Revenue Agency that they invested in or lent the money to the business. Keeping good records ensures that the loss can be claimed. The owner must also show that the company failed and that their investment or loan is not collectible. The bankruptcy of the failed company is the easiest way to prove that the money is not collectible. There are certain rules and restrictions in claiming an ABIL and a qualified professional should be consulted.
Andy Fisher is a Partner at Farber. His practice focuses on small business and corporate restructuring, along with personal insolvency. Andy can be reached at 416.496.3414 and firstname.lastname@example.org.