Owning your own business offers many opportunities. But it also carries inherent risks, including exposure to personal liability. These three tactics will help you protect your personal assets.
1. Incorporate your business.
Corporations might be legal fictions, but the protection from personal liability they afford to their directors, officers, and employees is real. At law, a corporation is a separate legal person and is therefore distinct from its shareholders, officers, directors, agents, and employees.
Incorporating your business helps limit your personal liability and shield your personal assets from risk. However, there are still certain circumstances in which a corporation’s directors and officers can be personally liable, for example, for the corporation’s unpaid GST and HST, unpaid employee wages and statutory remittances, and for fraudulent or criminal activities. Directors’ and officers’ insurance can help address some of these personal liability risks.
2. Limit your personal guarantees.
Business lenders understand that in many cases there’s a relationship between the financial health of a business and that of its owner. It’s therefore common for a lender to ask the owner for a personal guarantee of the business’s debts. This personal guarantee is a promise by you to be liable for the debts of your business. If your business defaults on its obligations, the lender has a contractual right to seek payment from you personally—including seizing your personal assets—to settle the obligation.
Your obligations under a personal guarantee depend on the type of liability you assumed under the guarantee. When presented with a personal guarantee, confirm that it’s a true prerequisite to the financing. Lenders might waive the requirement in certain circumstances, such as a strong credit score, collateral sufficient to secure the loan, or a reputable history of managing finances. If a personal guarantee is required, try to negotiate one or more of these options before you sign:
· a reduction of the personal guarantee with improved business performance or timely debt payments
· a limit on the personal guarantee to an actual dollar amount or a percentage of the outstanding loan or, if there are multiple business owners, to each owner’s percentage ownership (If you’ve agreed to an unlimited liability guarantee, your liability exposure is for the full amount of the business’s obligation to the lender. But if you’ve agreed to a limited liability guarantee, your liability exposure is limited to the agreed-upon fixed dollar amount or percentage of the outstanding balance.)
· no joint and several personal guarantees (If you can’t achieve this, try to limit and control who else will guarantee the obligation with you. If you’ve agreed to be jointly and severally liable with other guarantors under a personal guarantee, the lender can pursue any of the guarantors personally for the entire amount of the guaranteed obligation—so you could be personally liable for the entire amount on your own.)
3. Separate your business and personal assets.
If there’s a lawsuit against your business and there’s no legal separation between your business and your personal finances, your personal assets are in jeopardy. A key benefit of incorporation is that it creates a “corporate veil” that separates you from your business and shields your personal assets from exposure to the business’s liabilities. But when you comingle your business and your personal finances, a successful creditor might be able to pierce this corporate veil and go after your personal assets to collect on a liability of the business.
Safeguard your personal assets against this risk by keeping your business and your personal finances well separated and never comingle them:
· Maintain separate business and personal bank accounts and separate business and personal credit cards.
· Don’t use your personal account or card for business deposits, withdrawals, or expenses, and vice versa.
· Don’t move funds between your personal and your business accounts. Incorporating your business, limiting personal guarantees, and keeping business and personal assets separate will help minimize your personal liability and protect your personal assets.
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This article is information only; it is not legal advice. McInnes Cooper excludes all liability for anything contained in or any use of this article. © McInnes Cooper, 2023. All rights reserved.
Jillian Hickey is a corporate and commercial lawyer in McInnes Cooper’s St. John’s office, with a practice focused in corporate and business, energy and natural resources and tax. Jillian counsels businesses and their owners on matters including incorporation, business purchase and sale transactions, tax, and corporate governance.