How Business Owners Can Protect Themselves if their Business Fails

No one wants their business to fail. Business owners go into business with dreams of success and profitability. However, for a number of different reasons, it doesn’t always work out. Unfortunately, 15% of start-ups fail in year one and only 50% make it to their fifth year.

If your business has failed, it’s important that you take steps to protect yourselves from creditors, legal action and other situations. Failing to take steps to protect yourself if your business fails can have serious consequences.

Here are the top six ways to protect yourself.

1. Legally Separate Yourself from your Business

While sole proprietorships and partnerships are easy to set up, a potential problem with these business structures is that there is no legal way to separate the assets (and the debts) of the business from those of the individual owner(s). This means that, if the business ceases operation, the debts become the responsibility of the owner(s).

If a sole proprietorship or partnership files for bankruptcy, it is essentially filing for personal bankruptcy due to the lack of separation.

A corporate is a separate legal entity; the assets and liabilities do not belong to individuals who own the business. If an incorporated business fails, creditors can only go after assets that belong to the debtor company. That means that when an incorporated business winds down or becomes insolvent, most liabilities will not be the responsibility of the corporation’s owners.

2. Do Not Personally Guarantee Business Debt

If a company fails, anyone who guarantees a debt becomes personally responsible for it. This means that even if your business is incorporated and the debts are owed by the company, you will still be personally responsible if you have guaranteed the debt.

It is a common practice for banks to require a personal guarantee for small business loans, so you may not have much of a choice in this situation. However, while landlords and suppliers may also ask for a personal guarantee, you may be able to negotiate this aspect out of the deal.

3. Maintain Good Records

Keeping good records is crucial. For example, you will want to ensure that you have a record of any money that you have invested in or lent to the business. This will allow you to claim an Allowable Business Investment Loss (ABIL) in the event of the business losing money. An ABIL lets those who have lost money in the business write off a portion of this money against their personal income and reduce the amount of income tax they are expected to pay.

By keeping detailed records of your personal investments in the small business and how your assets are separate from the business, you can recover a portion of the money you lost through a reduction in the amount of taxes you have to pay personally.

4. Don’t Have Friends or Family as Directors Unless they are Active in the Business and Understand the Liability

Many people think it is a good idea to name a family member a director of a company (e.g. president, vice president or secretary). They often think that a person who is a shareholder has to be director. This is not the case.

Anyone who is a director of a company is personally liable for debts that are owed to the government for things like money deducted from employees for payroll taxes and HST. Directors are also personally liable to employees who have not been paid all of their wages or are owed for vacation pay. Making a friend or family member who is not involved in the business a director could mean that the person will be liable for a significant amount of money and could mean that they lose their assets or have to file for personal bankruptcy.

It is best to have as few people as possible as directors and to ensure only those who are active in the business, and understand the business and their level of responsibility are directors.

5. Get Professional Help as Needed

Many small business owners have an entrepreneurial spirit that causes them to want to do things themselves. This can lead to business success, but it can also mean that they don’t get professional help when they need it. This can be a mistake.

For example, it’s a very good idea to consult with a lawyer to make sure that you take security for any money you put in the small business and to ensure any security that you take is properly documented and registered. This will help you protect yourself if your business fails.

It’s also important to consult a lawyer when you are setting up the business. This will allow you to make sure that your personal assets are protected in the event of business failure.

You should also consult a Licensed Insolvency Trustee if your business is having financial difficulties. A Trustee is a person who has gone through extensive training and examinations in order to be licensed by the federal government to administer insolvency proceedings.

6. File for Bankruptcy if Necessary

Some people feel that they don’t need to file for bankruptcy if their business is in serious financial trouble. They believe that they can simply wind down the company themselves. This is not the case. A business cannot be legally wound down if it has liabilities that are not paid. In addition, there are potentially serious consequences if the assets of a business are sold and the creditors are not paid in full. For example, the creditors might not believe that the company’s assets are being sold for a fair price or that the proceeds are being distributed according to law. You could even leave yourself exposed to possible legal action as a result of these efforts.

If you file for small business bankruptcy through a Licensed Insolvency Trustee, the distribution of the company’s assets and the winding down of the company are handled by an independent third party who is also an officer of the court. Not only does this provide creditors with confidence that the process is being handled according to law, but the Trustee has powers that business owners may not have. When a Trustee sells assets, the company’s debts do not follow. However, if you sell assets yourself without a filing for bankruptcy, the debts may follow the assets, leaving you responsible for paying these debts.