For better or for worse, family and business often intertwine. The risks and rewards of one frequently blur with the other.
This article originally appeared in the May 2020 digital edition of the Ottawa Business Journal
While both are built with best intentions of permanence and stability, many do not last. Unfortunately, many don’t have the safeguards to protect them from each other in the event that one fails. The risk is real – in Ontario, approximately 40 per cent of marriages end in divorce. Only 51 per cent of businesses that enter the marketplace survive for five years, according to Industry Canada.
Without the right safeguards, the undoing of one can often have a domino effect on the other. And, the safeguards need to go in both directions.
If your business goes south and you haven’t taken the proper steps to protect your family, you could be facing significant liabilities and even personal bankruptcy. This poses a risk to your family’s assets – including savings, inheritances, and possibly even your home.
“Many people don’t realize the risk – we have seen families forced to carry the liability of failed businesses, and business ownerships dissolve at the hand of spousal disputes,” cautions Craig O’Brien, head of the commercial litigation practice group at Nelligan Law.
In both cases, it’s best to outline agreements and expectations early on when the goings are good and your relationship, whether business or personal, is harmonious. Otherwise you may be looking at disagreements and costly litigation down the road.
Protecting your family from your business
The key to protecting your family from potential business risk is to plan ahead for all possibilities. If you haven’t done it already, the next best time is now – as long as your business is still healthy.
In terms of structuring your business, a “wait-and-see” approach won’t always work. Many sole proprietors find out the hard way when the business has taken a downturn and it may be too late to restructure in order to protect personal assets from business liabilities.
A sole proprietor is personally liable for the debts and liabilities of the business. This means that the business owner’s personal assets, including assets jointly owned with his or her spouse, are exposed to the risks of doing business and may be seized and sold by business creditors in satisfaction of their debt claims against the business.
By comparison, the assets and liabilities of a corporation are separate and distinct from those of its owners. Accordingly, many business owners incorporate their businesses in order to protect personal and family assets from the risks of doing business.
It may be too late, however, when revenues are down and business debts are mounting, to restructure your business by transferring assets to a new or related corporation. In such circumstances, the transfer of personal assets to a corporate vehicle may be considered a “fraudulent conveyance” (a transfer made with intent to defeat, hinder, delay or defraud creditors), which in addition to potentially being declared void by the courts, may expose the transferor to further personal liability.
Depending on the nature of your business, it may therefore be advisable to incorporate at the outset, particularly if you are operating in a high-liability industry.
In all cases, whether operating as a sole proprietor or through a corporation, appropriate business insurance should also be obtained. Finally, a business lawyer can assist with mitigating business risks through contract, no matter what business form is used.
Ultimately, whether through incorporating, insurance or contract, business owners should be thinking about how to best protect personal and family assets from the risks of doing business from day one, because once the horse is out of the barn, it may be too late.
Unfortunately, in the current economic climate, some risk mitigation measures may not be available.
For example, consider being a sole proprietor retailer currently operating out of a leased space. Only a few months ago it would have been relatively normal to incorporate that business and have the landlord consent to an assignment of the lease to the company. Given our business climate, there is now virtually no chance that a landlord will agree to such an assignment without a personal guarantee, leaving the retailer exposed to potentially cataclysmic personal downside risk.
When setting up your business there are several steps you can take:
- Maintain good records – all transactions, financial statements, and invoices;
- Consider incorporating. A corporation is a separate and distinct legal entity from its owners (shareholders) and can protect your personal family assets from the liabilities of the business;
- Never commingle family and business expenses; and
- Purchase business insurance.
With these steps, a business owner can insulate their family in the event of a business issue.
Protecting your business during a breakup
Just as a business downturn can affect one’s family, a marriage breakdown can have disastrous consequences on a business.
A divorce – yours or any of your shareholder directors – can be catastrophic for your company’s assets and potentially the future of your business. There may be pressure to liquidate or otherwise encumber the business to allocate the monetary value to an ex.
Take for example a local software company with three partners, where one partner in the business is going through a divorce. Unfortunately, like too many businesses, a proper shareholder agreement was not put in place in the early hopeful days of the business, and as consequence there are no provisions for how family matters can impact shareholders.
“With the divorce rate being close to half, the odds of it impacting a business with multiple partners is much higher than people think,” emphasizes Marta Siemiarczuk, head of the family law practice group at Nelligan Law.
In this case, the business itself is technically safe, but the corporation may not be in a position to make difficult decisions in a timely way when one of the controlling minds is dealing with the extreme financial and emotional stress associated with a marital collapse. Significant tension between all shareholders may, in that context, ultimately lead to the demise of the organization if proper agreements and mechanisms have not been put in place within the business structure.
For residents of Ontario, the Ontario Family Law Act provides for an “equalization” scheme for the division of property when married spouses divorce or when they separate. The system equalizes the values of property that each spouse acquired during the marriage. The net value (all assets minus all debts) of each spouse’s property on the date of marriage is deducted from the net value of their property on the date of separation in order to determine each spouse’s “net family property.” If one spouse has acquired a higher net increase of family property accumulated during the marriage, they are required to make a payment to the other spouse of one-half the difference between their respective net family properties. This can lead one of your business partners being leveraged to the point of disaster.
“Unfortunately, owners can lose their marriage and business all at once – or end up having an ex as an unwanted anchor on the business,” warns O’Brien.
It may seem obvious, but it’s also important to remember that prenuptial agreements, cohabitation agreements and marriage contracts must be agreed to by both parties. That’s why it’s important to establish them early on when things are good and your relationship is amicable.
Business owners with shareholder partners have to worry about the stability of their business partners’ marriage as well as their own. If you are one of two or more shareholders of a private corporation, it is equally important that a shareholders’ agreement contains appropriate mechanisms for business continuity if the value of your co-owner’s shares become the subject of an equalization claim. Such measures should be coupled with a solid cohabitation agreement or marriage contract addressing spousal interests in a business.
Failure to ensure that at least one of these measures is in place (although really both should be in place) could eventually result in your being forced to co-own business with your now former, or your co-owner’s former, spouse.
When the family is part of the business
An issue can also occur when you or your spouse own a minority interest in a family business such as a restaurant, convenience store, campground or income properties with other relatives. The problem becomes, how will shares in the business be valued for the purpose of dividing your property?
Another common issue involves determining actual available income from a business you or your spouse control for the purpose of child and/or spousal support obligations. If for example, your spouse owns an IT consulting company and pays him or herself a salary, it may not be a true reflection of the income available to him or her.
“In these situations, the legal costs of outlining a plan before this got messy is minimal compared to the financial costs of litigation,” says Siemiarczuk.
The takeaway is that what works for the Canada Revenue Agency or for accounting purposes may not work in a family law situation where support is an issue. The legal rules are different. If you or your spouse has an interest in a business, resolving these issues can be very complicated, and no matter how solid your relationship, you should have a cohabitation agreement, marriage contract or shareholder agreement in place. Without one, the consequences can be cataclysmic, both for you and your spouse and for the business.
Even if your business is already in trouble, or you’re in the midst of a separation, an experienced lawyer can still help you. They may be able to help you find an arrangement that meets your needs while managing any tax consequences that arise. Having a legal team that practices both family and business law can help ensure you have all your bases covered.