by Stephen Leblanc
Losing a business is heartbreaking. Losing all your personal assets at the same time is a disaster. Here are some tips to protect your retirement nest egg and your home should the worst-case scenario occur.
Most business owners invest a great deal “financially, emotionally and physically” in creating a successful venture. That’s why it’s critical to be prepared for the worst-case business scenario and put plans in place to protect those hard-earned assets from creditors.
No matter how large and/or successful your business is right now, you still face risks. Your usual markets could dry up; something Canadian ranchers are well aware of after the BSE crisis. Your costs could increase dramatically, consider the soaring prices for fuel and fertilizer. Or competing products or vendors could arrive on the scene. These and other situations can very quickly put your business at risk and even totally wipe it out.
Owners can take a number of pre-emptive measures to help protect or “creditor-proof” their businesses and personal assets so they won’t lose everything should their business encounter financial problems. It’s preferable to implement these plans at the time of business start-up when assets are few, or while the business is solvent and there are no pending claims against it. Once claims have been filed it is too late to move assets beyond the reach of creditors.
Creditor-proofing requires both financial and tax planning and encompasses your personal assets and business holdings. Strategies for creditor-proofing are not meant to replace insurance coverage. Rather, the type and amount of insurance you take should be an integral part of your credit proofing plan.
Following are some more common creditor-proofing strategies business owners should consider:
Incorporate your business. If you operate your business as a sole proprietorship or a partnership, creditors can sue you and file claims against personal assets such as your home and investments, and against business assets. If you incorporate your business and it becomes a legal entity of its own, your personal assets will not be at risk if you’re ever sued. This is providing of course that statutory liabilities, personal guarantees and other activities (e.g., shareholder distributions made under insolvency conditions or director/officer fraud) are otherwise absent. Corporate directors also need to ensure that statutory obligations such as GST, PST and payroll remittances are paid on a timely basis to avoid any personal liability since governments are considered priority creditors.
Avoid personal guarantees. Try to avoid giving any personal guarantees against corporate debt unless absolutely necessary. This includes personal guarantees to financing institutions, suppliers, landlords and others. Be aware, though, that many financial institutions may, depending on the financing circumstances, require a pledge against personal assets to acquire business loans. However, it is often possible to renegotiate with financial institutions for the cancellation of personal guarantees as the business grows in value.
Create a holding company. Set up a parent company to hold the shares of the operating company or set up sister companies to hold assets such as real estate or equipment that can be leased to the operating company. You’ll be able to eliminate or reduce retained earnings from the operating company by paying tax-free dividends to the holding company. The holding company then can reinvest these dividends and build up assets where they are safe from creditors, and the income in the operating company will be subject to a lower tax rate using small business deductions. Should the operating company ever need funds, the holding company could provide a secured loan.
Make secured shareholder loans. When you make shareholder loans to your incorporated company that are secured via registered mortgage or general security agreement, it makes you a secured creditor. This means you’ll have first rights to corporate assets if the company does run into financial trouble.
Buy insurance-based investment and retirement products. Investment and retirement products (such as RRSPs, annuities, universal life policies and segregated funds) held in life insurance companies are usually creditor proof under provincial insurance legislation if the named beneficiary is a spouse, parent, child or grandchild of the person whose life is insured. Although the federal government has proposed new legislation that would creditor proof RRSP savings in the event of an employer or personal bankruptcy, it could take some time to see exactly what amendments might be implemented both federally and provincially for those provinces that have not already enacted similar consumer protection legislation.
Set up spousal RRSPs. Another strategy is to put at least some of your retirement savings into a spousal RRSP, which would be safe from creditors as long as your spouse is neither a director of the company nor a guarantor for any of your personal or business debt. A spousal RRSP could also reduce tax payable on future plan withdrawals.
Create individual pension plans. If you own an incorporated business and your annual T4 income exceeds $100,000, you can set up either an individual pension plan (IPP) or a retirement compensation arrangement (RCA). You can contribute more to these plans than to a traditional RRSP, and the contributions are both fully deductible by your company and a non-taxable benefit to the beneficiary. Creditors of the plan member or sponsor cannot seize assets in either an IPP or RCA.
Put personal property in the name of family members. If you put your personal assets such as your home or car in the name of your spouse or adult children, they are creditor proof provided the family member is neither a director nor a guarantor for any of your personal or business debt. If your spouse also is at risk, you could transfer the family home to a “principal residence trust,” naming several family members as discretionary beneficiaries.
Talk to your legal, accounting and tax advisors if you haven’t already adopted creditor-proofing strategies for your business and personal assets. They can help you set up the best protection for your particular situation. Also consult these professionals immediately if your business finances do take a turn for the worse. Early advice could save you.
Finally, if your business does fall on hard times and you haven’t taken steps to protect yourself against creditors, know when to give up voluntarily. A creditor-forced termination of your business would be your least palatable ending. You don’t want to lose all of your personal assets as well while trying to save the business.
Stephen Leblanc is a Financial Advisor for Miramichi and surrounding areas for Front Gate Financial Group. He finds solutions for his clients’ financial situations. “I have been a financial advisor since 2007 and I am motivated when it comes to helping others. I deal with every different bank and numerous insurance companies that guarantee the best rates and products.” Stephen specializes in Life Insurance, Critical Illness, Disability, RRSPs, Annuities, Pensions, RESPs, Blue Cross, Group Plans and Mortgages. In his spare time Stephen is an active member of the community coaching Miramichi Minor hockey, enjoying all kinds of sports and spending quality time with his family. For more information visit his website at StephenLeblanc.ca.