Recently, I lunched with the poster boy for entrepreneurs who crash and burn but live — quite comfortably — to tell the tale. A few years ago, Bill (not his real name) came to see me for some advice on expanding his business. I gave it to him — and he ignored almost all of it, ending up in corporate and personal bankruptcy. Still, he managed to keep his house and all of his personal investments, and today is doing just fine. Why? Because he followed my most critical bit of advice: protect yourself from creditors.
The reality of entrepreneurship is that we expose ourselves to a triple whammy of risks. First, as officers and directors of our companies, we take on many statutory liabilities, such as tax and other source deductions, workers’ comp and GST. You may have personally guaranteed all or part of your company’s debt, or mortgaged your home to finance your business.
Second, by plugging profits back into the business rather than making outside investments, you take higher risks but receive lower current returns. (It’s the unfortunate irony of being in business for yourself, especially in the startup phase.) And when we do feather our personal nests, we tend to make riskier investments than the average Joe.
Third, we become so involved in our businesses that we don’t attend to our personal finances in the most thorough or timely manner. Simple tasks such as writing a will, assigning powers of attorney and purchasing life or critical illness insurance are often put off to a later date.
As it was to Bill, my advice to you is to put your personal house in order — now — because you never know if, when or how your business will be side-swiped.
Start by managing your risks. Take money out of your business from time to time and invest it conservatively in a diverse portfolio. Wherever you put your money, protect it from your creditors. Here are a few options:
Place assets in your spouse’s name
Provided your spouse isn’t also an officer and director of a company, has signed for your business loan or has other potential liabilities, place your assets in his or her name. Although this is the simplest and least expensive creditor-proofing strategy, it is highly effective. Bill got to keep his home because it was in his wife’s name. Also consider safeguarding your retirement savings by contributing to a spousal RRSP.
Buy segregated funds
Bill also used segregated funds to protect some of his personal financial holdings. “Seg” funds are essentially mutual funds purchased through an insurance company. Because the investment takes the form of an insurance contract, it is exempt from seizure by creditors. Most major insurance companies offer a wide range of mutual funds so that you can select a portfolio that is consistent with your personal investment objectives. While the management expense ratios (MERs) for segregated funds are slightly higher than the fees payable for the same mutual fund purchased outside of the insurance contract, consider it a small price to pay.
Start your own pension plan
An individual pension plan (IPP) offers another relatively inexpensive way to protect your retirement savings. As the name suggests, an IPP is a defined-benefits plan that you can set up for yourself. Like traditional pension plans, IPPs are administered as trusts and are creditor-proof. A further benefit is that IPP contributions, unlike RRSP deposits, are not fixed; rather, your maximum tax-deductible contribution increases every year. However, because IPPs are complicated investment vehicles, seek the help of a financial advisor with IPP expertise. (Warning: more advisors claim to understand IPPs than really do.)
Set up a family trust
Here’s how it works. You pay a lawyer to set up a trust of which you and your family members are “contingent” beneficiaries — contingent meaning you have no absolute right to the trust’s assets, which are distributed at the sole discretion of the trustee. Because you aren’t guaranteed to receive some of the assets, your creditors cannot take them. Note that there are occasions when a court will order the trustee to turn assets over to creditors, particularly if the trust was established on the eve of an insolvency.
Send your trust offshore
You can add a belt and suspenders to your trust by placing it offshore in the hands of a foreign, third-party trustee. This strategy places your holdings outside the jurisdiction of the Canadian courts and, depending on the country you choose, under the additional protection of that country’s statute of limitations.
One caveat: if you place assets into any of these vehicles while you are technically insolvent, your creditors may have the legal right to trace the assets, unwind the creditor-proofing steps you’ve taken and seize your nest egg.
Bill is now a creditor-proofing convert who is getting his insurance licence so that he can sell segregated funds to other entrepreneurs. Bill may have lost his business, but he landed on his feet. Will you?