Legal Ease

A primer on debt-financing

Debt Financing is a fancy way of saying that you're borrowing money for your business.  Your repayments will likely include principal and interest.

Sources of Debt Financing:

You: Sure, you can loan money to your own business. Shareholder loans can result in tax savings.

Friends and Family: The most common advantage is that they may charge you a lower rate of interest and flexible payment terms.  There is a risk, of course, that you might cause damage to your personal relationship in the event that things go awry.

Financial Institutions: Banks, trust companies, commercial lenders are always looking to lend money to viable businesses.  Expect a thorough due diligence process, extensive documentation and possibly some restriction on how you run your business (and possibly some loss of control) before they "show you the money"

Government Loans: There are various programs available through the provincial and federal government for eligible businesses.

Types of Loans

Small business loans generally fall under two categories:

Operating Loans - These are loans to finance the day-to-day operation of your business and these loans are generally required when your business runs into cashflow problems.  There are four kinds of operating loans:

(a) Revolving Line of Credit - a reserve fund that you can dip into periodically and keep contributing to when cash is readily available.

(b) Non-Revolving Line of Credit -  loan given for a specific purpose such as the purchase of a new machinery or vehicle.

(c) Inventory Loan - As the name suggests, the loan is restricted to the purchase of inventory for the business.

(d) Accounts Receivable Loan - loans made based on the value of monies owed to you by your customers.

Term Loan - Usually a set amount for a specific purpose, the term loan matures over a specific period (one to five years is common) and the borrower makes regular payments of principal and interest.

Loans can either be secured or unsecured.  A secured loan is where the borrower pledges certain collateral to the lender which the lender can call on to recover the loaned amount (in the event the borrower defaults on payments).  Unsecured loans, in contrast, have no collateral pledged against the loan.

As a small business, you can expect that banks are likely to want to secure the loan (and thereby assure payment).

Financing your small business

So you've got yourself a business but you will still need money, or financing, to run your business.  There are two ways to obtain that money: through borrowing (debt-financing) or through equity (non-debt financing).  In this article, I will explain these concepts and set out what you should consider to determine what form of financing is most suited to your business needs.

Equity Financing:  Equity refers to a right of ownership in your business.  That right is generally directly proportional to the amount of money or property contributed into the business.  Equity usually also reflects a person's ability to control the business and profit from its success.

Equity Financing is therefore a contribution of capital in exchange for a right of ownership in your business and your financier becomes an investor in your business.

Sources of Equity Financing:  Yourself, of course.  Your friends and family.  Third Parties.  Banks and Institutions.  Government.  You should know, however, that securities law in Canada prohibits you from making public offerings of securities (including shares in a company) unless you comply with applicable registration and prospectus requirements.

A Note on Securities Legislation

The Private-Company Exemption: If you  do not propose to offer your securities to the public (interestingly enough, the legislation does not define public.) and your company's articles contain the relevant private-company restrictions (restrictions on share transfers, limit the number of shareholders etc.), you are generally exempt from registration and prospectus requirements.  These private company restrictions appear in the articles on most small businesses. 

So, if you incorporate a company and issue shares only to yourself or a a limited number of shareholders with whom you are personally acquainted and that are in the business with you then, arguably, you are not offering shares to the "public". 

Private Placements: In the event that your business requires a large sum of money and you wish to raise this by offering securities but without having to go through the registration (as an issuer) or preparing a prospectus, you may wish to consider a private placement of your securities.

Securities legislation acknowledges that a detailed disclosure document (such as a prospectus) would be redundant in circumstances where the prospective purchasers were all sophisticated investors or in which the offer to buy securities was made to a limited number of people (usually no more than 50) and an actual sale to no more than 25 took place. In such circumstances, companies can avail of certain exemptions which exempt them from registration and prospectus requirements.   You instead provide your investors with a document known as an Offering Memorandum.  An offering memorandum is not a public document and need only be presented to potential investors.  This is a significant advantage where privacy is a concern.

Lastly, raising capital by way of a private placement allows you to maintain the tax benefits associated with private-company status.

I will talk about Debt Financing in my blog next week! Stay tuned.

Should I incorporate?

The most common reason cited for incorporating a small business is that it helps you to limit your personal liabilities. Legally, a corporation is considered a "person" with its own identity separate from the "identity" of the individual owners of the corporation.

A person generally becomes an owner of an interest in a corporation by investing cash or other property in exchange for shares issued by the corporation. A person with that ownership interest is called a shareholder. A shareholder's liability is limited generally to the value of the cash or other property contributed to the corporation in exchange for the shares. Therefore, generally, the shareholder's assets not invested in the corporation are safe from the corporation's creditors.

So, theoretically, if a corporation is sued and loses, only the corporation, not the individuals who own the corporation would be responsible for paying court-ordered damages.

In reality, however, what most small businesses fail to appreciate is that this liability shield is not all that effective in providing you with personal immunity when you are the sole owner of a very small corporation.

Incorporating a one-person or very small business seldom protects the owner(s) from liability should the corporation default on a loan or lease. Banks, landlords and others often require personal guarantees on loans and leases, and if you make such a guarantee, then the corporate form of business will not offer you much protection from personal liability.

You may also become personally liable for corporate debts if the corporation if the corporation is operated as a mere front for its shareholders rather than for corporate purposes. Further, if you do something that is downright negligent then it is likely that the negligent person (you) and the corporation may both be held liable.

Under some circumstances, corporate officers may be held personally responsible for the corporation's failure to pay provincial or federal taxes.

You cannot give yourself immunity merely by incorporating.

It should also be noted that incorporation involves certain costs (compared to operating as a sole proprietorship).  These costs include fees to be paid to the government for the application fee, the NUANS Name Search Report and the professional fees for financial and/or legal services.

Incorporation also means more paperwork. You will be required to notify the government of changes in the address of the registered office or of a change in the directors. Furthermore, the government requires that you keep and update certain corporate records, such as Directors' Register, Shareholder Register, minutes of all meetings, resolutions, etc.

And if you hate doing your personal taxes you should be aware that a corporation is required to file a separate tax return from the owner(s). If you have been operating as a sole proprietor, you can no longer report business profits and/or losses directly on your personal tax return.

That said, there are many benefits to incorporating.

1. An Enhanced Image: You are able to project a better image of your business. Incorporated businesses often appear to have more credibility. Consumers, vendors, and partners may prefer to do business with an incorporated company.

2. Succession Planning: It is much easier to transfer the business to other or your family members. A corporation can have a perpetual existence, and it is not affected by the death, withdrawal, or entry of shareholders, officers, or directors. The corporation can simply continue its business uninterrupted by such events, and only the ownership of the shares in the corporation is involved. This ease of transferring of shares facilitates family estate planning, gifts to children, intra-family sales, transfers between shareholders, and compensation of key employees.

3. Obtain Financing: This ease of transferring shares also facilitates the financing of the corporation through the issuance of shares to interested investors.

4.  Tax Benefits: A corporation (especially an active Canadian controlled private corporation) may be able to enjoy various tax benefits (lower tax rates, incentives and subsidies for eligible businesses etc.).

It is usually a good idea to speak with your accountant and/or your lawyer to discuss these points before deciding whether or not incorporation is the best course of action for you.

Mind your own business: Sole Proprietorship

The simplest and least expensive way to carry on a small business in Canada is the Sole Proprietorship.

As the name implies, a sole proprietorship means a person in a business for himself or herself. A typical example of businesses that are some times conducted as sole proprietorships is a student painter, a`DJ for parties, or someone who is just starting up a business or is already employed full time elsewhere. Basically, you are the business!

You don't need any formal paperwork to set yourself up as a sole proprietor. As soon as you engage in some sort of a commercial activity - you are doing business as a sole proprietor.  You may still require licenses or permits to engage in certain types of commercial activity. For example, you may wish toperate a plumbing business as a sole proprietor; however, to do so legally, you must be licensed by the h to municipality in which you plan to carry on that business.

As a sole proprietor, you may carry on business under your own name or a name other than your own provided that where a business name (such as "Geek God") is used, such business name is first registered under the Business Names Act.

Advantages and Disadvantages

To determine whether you should operate your small business as a sole proprietorship, consider some of this structure's advantages and disadvantages.

1. Advantages

There are several advantages to operating your small business as a sole proprietorship:

• You can start doing business right away. The informality with which you can start a business makes this very unappealing.
• It is inexpensive compared to other ways of carrying on a small business. Incorporation requires maintaining books, filing a separate tax return and several other formalities.
• All the assets of the business belong to you personally. Whether it's your truck or your tools.  The assets of your business are yours.
• You can use your business losses to reduce your personal income tax. If your business makes a loss you can offset that against your other income and bring yourself into a lower tax bracket.
• Easy to terminate - simply stop engaging in your enterprise.

2. Disadvantages

As you might expect, there are disadvantages to sole proprietorships:

• Just as the benefits of the business belong to you personally, so too do the obligations.
• As an individual is taxed at a higher rate than corporations, a sole proprietor cannot take advantage of more favourable tax treatment afforded to incorporated businesses.
• A sole proprietor may find it more challenging than a corporation to obtain loans or get credit from suppliers.
• No opportunity for succession - the business cannot be passed on after you die.
• Your liability for things you do in the course of operating your business is unlimited and it's personal. The risk associated with unlimited liability is the single biggest deterrent to carrying on business in the form of a sole proprietorship. To avoid that risk, you must either incorporate a company and do business that way or procedure adequate insurance against any possible mishaps.

Is a sole proprietorship right for you or should you incorporate?  I'll talk about incorporation in my next entry.

Where there is a will....

How often have you asked yourself, “Do I really need a will?”

To answer that question, you need to ask yourself one more question: “Do I care about what happens to my estate after I die?”

If you don’t, then you don’t need a will because if you die without a will, the law will make one for you! This essentially means that the provisions of the Succession Law Reform Act (the “SLRA”) will apply and your estate will be distributed in accordance with the SLRA depending on your unique situation.

However, if you are not satisfied to have the administration of your estate to be governed by the SLRA and want to be proactive about issues such as the custody and guardianship of children, who gets what after you die, minimize taxes and other government fees (levied on your estate or your beneficiaries), and making sure that your preferred charities and friends receive any bequests you would like to leave them then you do need a will.

I have listed below some typical scenarios that may exist at the time of your death and how the SLRA deals with them:

You die without a will and are survived by your spouse and there are no surviving children or grandchildren

In this situation, the SLRA provides the surviving spouse is entitled to the deceased's property absolutely. Should you wish others to benefit from your estate then you need to set this out in your own Will.

You die without a will and are survived by your spouse and children

In this situation, the SLRA states that the surviving spouse gets a preferential share. The balance is divided between the surviving spouse on the one hand and the children on the other. The preferential share of an estate is $200K.

If it is your intention that your spouse should receive the whole of your estate, and your estate has a value of less than $200K, you may not need a will if the only purpose would be to transfer your property to your spouse.

If your estate is greater than $200K, the SLRA provides that if you are survived by a spouse and one child, the balance is divided equally between your spouse and that child. If your estate is greater than $200K and you are survived by a spouse and more than one child, then your spouse will get one third of the balance, and your children will divide the remaining two thirds equally among themselves.

A Note on Second Marriages

The SLRA makes no distinctions between first and second marriages. So, if a person dies without a will and is survived by a second spouse, the second spouse will take the preferential share and divide any balance with all of the children of the first marriage. If both parties to the second marriage have children from an earlier marriage that they wish to protect, it is essential that they both have a will. If they do not, on the death of one of them, the surviving spouse would inherit from the estate of the other assets having a value equal to the preferential share of $200K plus a share of any balance.

In most cases, that will be the whole estate. The children of the party first to die will receive a share of the surviving spouse's estate only if the surviving spouse makes a will leaving a share of his or her estate to them.

You die without a will and are survived by children and no spouse

In this situation, the SLRA will divide your estate equally among the children. If any child has predeceased his or her parent, and such child in turn has children (that is, grandchildren of the person who has died) such child's share is divided equally among his or her children.

It does not go to the spouse of such child. If such child had no children, his or her share is divided equally among his or her brothers and sisters.

You die without a will and are survived by a common law spouse

First off, the rights of a common law spouse are not the same as those of spouses who are married. A common law spouse has no property interest in the estate of the other common law spouse. Accordingly, if one of them should die without having made a will, the other would not be entitled to the deceased's property.

The surviving common law spouse might have a claim for support from the estate as a dependant, but would not be entitled to assets by virtue of their relationship. So, if you are living in a common law relationship with another, you will have no protection on the death of the other unless the other has a will naming you as the beneficiary.

You die without a will and are survived by no children and no spouse

In this situation, if the person is survived by a parent or parents, such parent or parents inherit the whole estate. If the person who has died has no surviving parent or parents, his or her share is divided equally among his or her brothers and sisters.

If any of them have predeceased the person who has died, the share of such brother or sister is divided equally among his or her children. It does not go to the spouse of such brother or sister.

You should now be able to determine whether or not you need a will.

The benefit of having a Will is that it speaks for you from the moment of your death. It allows you to decide who will look after your affairs, who is to inherit what they are to inherit. It allows you to benefit family members, friends, organizations or charities which may not be possible if you died without a Will.

What Will It Cost?

A simple will drafted by and executed in the presence of a lawyer will typically cost you around $200 plus GST and disbursements. Complex wills that require setting up trusts, tax planning, conveyances of property etc. will generally cost more (based on time spent by the lawyer).

DIY Wills

You can also purchase ready made (Do it Yourself) will packages from Grand & Toy and other stores (or even online).

These are effective but only if you are able to understand the terms being proposed and can competently (without ambiguity) set out your wishes. When attempting to make the wording fit the framework of the form, making errors is easy. Any drafting mistake can cause misinterpretation and even void the Will. It often takes a court, and solicitors, to sort it out. Expenses are taken from the estate.

Legal Aid in Ontario

I am often asked about the mechanics of legal aid and the criterion for qualification for legal aid. Legal aid is not restricted to community legal clinics.  Many lawyers/law firms in private practise also offer their services to clients that qualify for legal aid.

Legal Aid Ontario is an agency that receives funding from the provincial government to provide legal services to people with low incomes. Legal aid has two main components:

• The community legal clinic system; and
• The legal aid certificate program.

Community legal clinics are staffed by lawyers, community legal workers and sometimes law students. Legal clinics provide representation and advice on various kinds of legal issues. To receive services from a clinic, you must live in the area it serves. Some clinics also provide brief advice, or "summary advice", without asking about your financial situation.

If you want a private lawyer but cannot afford one, you may be able to get a legal aid certificate from legal aid. Most certificates pay your lawyer's fees and expenses, but some pay only expenses. You can get a certificate for some type of legal problems, but not all.

Legal Aid is available to low income individuals and disadvantaged communities for a variety of legal problems, including criminal matters, family disputes, immigration and refugee hearings and poverty law issues such as landlord/tenant disputes, disability support and family benefits payments.

Legal aid offers different kinds of services, depending on the client's needs. Legal aid is available through the certificate program, which entitles clients to receive advice and representation by private lawyers or by legal aid staff lawyers. To apply for a legal aid certificate, you must attend in person at a local legal aid office If you are eligible for legal aid, you can get a legal aid certificate that you can take to the lawyer of your choice. As stated above, legal assistance is also available through the community legal clinic program.

Every Ontario resident who needs legal assistance can apply. Eligibility for legal aid certificates is based on financial need and the type of case. The applicant may pay nothing or a portion of the cost of legal aid, depending on their financial situation.

When you go to a legal aid office to apply for legal aid certificate you should take as much information as possible including:

• Court papers, if you have been served with any
• Identification documents
• Proof of your current income i.e. 3-4 recent pay stubs, income tax return or notice of assessment for previous year; welfare statement of income or employment insurance statements
• Up-to-date bank books
• Proof of monthly expenses and bills (rent receipt or mortgage payment, hydro, gas, car payments receipts, credit card statements, car insurance bill)
• Deed for your house
• Proof of any unusual expenses such as medical costs.

If legal aid decides that you have enough money to pay a lawyer yourself, you will not be given a certificate. If you get a certificate, you may be required to sign a payment agreement. This means that you agree to pay legal aid back for some or all of your legal fees and expenses.

Take your legal aid certificate to a lawyer who accepts certificates.

Taking a Child Outside the Country

With the holiday season upon us, many among us are making travel plans.  However, if these travel plans include taking a child outside the country (that will not be accompanied by both parents) then it is recommended that the traveling parent (or adult guardian) carry a Consent Letter from the other parent(s).

It will also make your life a lot easier if this letter is notarized. According to the Department of Foreign Affairs and International Trade Canada, It is strongly recommended that children travelling alone or with one parent carry a consent letter for each and every trip abroad. Although anyone can witness/sign these letters, it is advisable to have the consent letter certified, stamped or sealed by an official who has the authority to administer an oath or solemn declaration (i.e., a commissioner for oaths, notary public, lawyer, etc.) so that the validity of the letter will not be questioned.

Having a document notarized simply means that the document has been reviewed by or signed in the presence of a Notary Public. A Notary Public is a person authorized under the Notaries Act to do various things, including commission documents, but also including certification of documents as true copies and to verify signatures.

Sample Consent Letter from Parent

To whom it may concern:

1.  I, Deepak Chopra, am the husband of Renu Chopra.  The child, Priyanka Chopra, born March 12, 2002 is our daughter.

2.  I/We reside at [insert address] in the City of Toronto in the Province of Ontario.

3.   My wife Renu plans to take our daughter, Priyanka, on a holiday to India in the period from December 22, 2007 to January 8, 2008.

4.  I consent to my daughter, Priyanka, being taken out of the country by my wife for the aforesaid vacation.

5. I can be reached during the day via telephone at [insert number].

[Signature]

Deepak Chopra

Lawyer fees to notarize a document can vary quite a bit.  Bay Street lawyers typically charge anywhere between $35 to $60 for notarizing a document. The job itself is very straightforward and does not require any specialized experience so there's no need really to pay a premium for these services.

Most local lawyers (especially sole practitioners) can offer quick, efficient and affordable notary services starting from around $20.  So shop around and make a few calls first.

The money you save can go towards some extra souvenir shopping! :)