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SMB owners: Make sure your personal finances are protected

Most experts agree that for the majority of businesses, once they get past a certain size, incorporating is the best way for entrepreneurs to protect themselves.


It was a cold New Year's Day in 2009 when Denis Staples got the call. His 95,000-square-foot factory just outside Ottawa was on fire. When the disaster ended, almost nothing would be salvaged. It was hard to imagine how Deslaurier Custom Cabinets Inc. could go on.

"We had just ended our best year ever, and we had an entire month of production in the works," Mr. Staples said. "Then we went to hardly anything – no phones, computers, materials. It was shocking to go from the best shape in the company's life to really nothing."

The future of the business was very much in question. Mr. Staples and his business partner had another, more personal, fear: what it would mean for their own personal assets. Would their savings be at risk if the business ended?

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Most businesses that find themselves in difficulty get there for reasons less dramatic than a fire or other sudden disaster. It's usually more pedestrian stuff such as losing key customers, taking on too much debt or failing to keep up with a changing marketplace. But the issue is the same – how can a business owner protect their personal assets so they're not at risk if the business fails?

For Dave Cook, it all begins with running your business well.

"Look after customers, clients, other stakeholders and you won't get into trouble in the first place. I can't emphasize that enough."

Mr. Cook is a partner with KPMG Enterprise. He has several specific recommendations for entrepreneurs to avoid getting into difficulty. They include getting good legal advice for contractual obligations, carefully watching cash flow, and keeping an eye on preferred creditors.

One fundamental issue is the structure of the business. The decision to operate as a sole proprietor, partnership or corporation can make all the difference in protecting your personal assets if your business runs into trouble.

"Reducing exposure to creditors is a key factor to consider when deciding on a business structure," says Abby Kassar, with high-net-worth planning services at the Royal Bank of Canada's RBC Wealth Management unit. "A sole proprietor is the simplest form of operating a business and the least complex and expensive. But it exposes your business and personal assets to possible claims of creditors."

Other structures may make more sense. A partnership is similar to a sole proprietor but you operate the business with a partner and you may be liable for the actions of your partners. In a partnership your personal assets are subject to claims of creditors – unless you are a limited liability partner, in which case your liability is limited to what you have contributed to the business.

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Most experts agree that for the majority of businesses, once they get past a certain size, incorporating is the best way for entrepreneurs to protect themselves. A corporation is a separate legal entity that allows the business owner to operate the business while protecting their own personal assets. And as a shareholder, the business owner's liability is generally limited to the assets invested in the corporation.

Regardless of the structure, another key bit of advice is to keep your business accounts and liabilities completely separate from your personal assets and liabilities.

"It's cleaner for tax and audit purposes," says Shane Lawrence, associate vice-president of business banking at TD Canada Trust.

"It also helps you get a complete picture of how your business is doing. For example, if you are continually using your personal line of credit to finance the business, you may be hiding from yourself the fact that the business is doing poorly. This can cause you to over-invest in your business and dilute your personal worth."

Insurance can also be a crucial piece of the puzzle. It certainly was for Mr. Staples. He says it was one of the keys to Deslaurier Cabinets getting back on its feet.

"No one wants to read an insurance policy, right? But there's tremendous value in reading and listening to the experts in the field. We made two important changes in 2008: fully documented all of our factory improvements and expanded our 'business interruption' insurance." Mr. Staples says the business may not have survived without the policies.

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Mr. Cook of KPMG says product liability insurance and a detailed life insurance plan are also important parts of the picture. He can rhyme off several other steps that can protect small business owners, including shareholder agreements and avoiding personally guaranteeing any business obligations.

"Also, take some chips off the table. Many business owners don't. If it's not going to prevent the business's growth, there are ways to withdraw funds that are tax effective," says Mr. Cook.

Ms. Kassar of RBC also has some additional tips, including maximizing contributions to RRSPs, since in many provinces they are protected from seizure in the event of bankruptcy. She also recommends gifting assets to family members to reduce personal assets exposed to creditors.

Deslaurier Cabinets was able to resume its operations not long after the devastating fire. It now has a new factory facility in Renfrew, Ont. – smaller than the old one, but more modern. The company continues to grow and expand.

Mr. Staples says planning and perseverance were the keys to keeping the business going. "We never really stopped to feel sorry for ourselves."

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