You’re a small business person who has incorporated a company for your business. Why? For dozens of reasons, but chief among them is that you want to make sure the corporation, not you personally, takes the risk of the business failing.
Corporations don’t die like people and can live forever – unless you legally kill them by winding them up or letting them die by failing to file annual returns. Corporations are separate legal entities from their owners, meaning that the owners (“shareholders”) of the corporation aren’t the same legal “persons” as the corporation itself. And you can share ownership among a number of shareholders in differing percentages within the company, reflecting differing levels of investment or participation in the business’s operation.
The corporation will be notionally run through directors elected by the shareholders, although in small companies, the directors and shareholders are, more often than not, the same people. But you might have shareholders who don’t want any role in management or the selection of directors (they just want dividends or share appreciation).
You can create different classes of shares with different rights attached to them. For example, some shareholders may own shares that pay dividends, but there is no right to vote for the directors. Other shareholders may own a different class of shares that give the shareholders the right to vote for the directors. And of course, there are certain tax planning benefits that one can take advantage of only by using a corporation. Simple stuff, right?
But one of the main reasons to have a corporation is to shield you and your shareholders from personal liability in the event the business fails and the people who extended credit want their money back. Banks, suppliers and other creditors who contract with your company can sue only your company, because the company is a separate legal entity from its owners.
But this doesn’t stop banks, landlords, franchisors, suppliers and others from demanding, as a condition of doing business with your company, that you – the walking, breathing person with the house, the work ethic, the savings accounts, and the terrifying fear of losing it all – must provide a personal guarantee, personal indemnity or some other form of personal covenant that obliges you to personally pay all your company’s debts should your company crash and burn.
First, when one starts a business, some bulletproofing may be in order. Just because the franchisor or the landlord requires a personal guarantee from the spouse of the business’s principal doesn’t mean the spouse should be agreeing to this holus-bolus. Many spouses aren’t involved in the operation of the business except in a tangential way, yet they are asked to give a guarantee along with their husband or wife for a substantial sum of money. Granted, if the husband and wife are actively running all facets of the business, are both directors and officers and own the company on a 50/50 basis, it will be hard to convince a bank, franchisor or creditor that “my spouse isn’t involved in the company so he or she isn’t giving a personal guarantee.”
But adding your non-involved spouse as a director, officer and shareholder may be putting the couple in the position where the franchisor, bank or landlord wants both you and your spouse to guarantee the company’s obligations, or there’s no deal. So it’s not always a good idea to involve your spouse in the business through shareholdings and directorships.
Secondly, an unlimited guarantee of your company’s obligations to a landlord or franchisor (especially if the company runs into financial trouble) might make for many sleepless nights. The house and the personal savings are on the line. It’s one of the most troublesome issues my prospective franchisee clients face when they’re asked to personally sign (or guarantee) their company’s obligations for five or 10 years. “Who knows how much those obligations could be? It’s all too uncertain. We could lose everything.”
Try to cap the guarantee in terms of dollar amounts, or years or both. Although admittedly, it’s almost impossible to do this with banks, franchisors, landlords and other creditors may well entertain a cap. Try to cap it to an amount you can live with. Maybe the franchisor is prepared to limit your personal guarantee or personal covenant to an agreed-on amount, such as the amount of the initial franchise fee (say $25,000). This may well give you the certainty and comfort you need to jump into the deal. If everything goes to hell in a handcart with the business, the company’s exposure to the franchisor might be hundreds of thousands of dollars, but your personal exposure is only $25,000. You might say: “I can live with that.”
Or you can try to cap the personal guarantee in terms of years; that is, you’ll agree to personally guarantee the contract if you have to, but your guarantee expires in two or three years (about the same time the business is expected to start making money).
Just because you and your spouse are asked to sign a guarantee or other personal covenant that obliges you to pay for your company’s debts, it doesn’t mean you or your spouse has to give it. There are things you can do to reduce your personal exposure, and help to avoid some of those sleepless nights.
Special to The Globe and Mail
Vancouver franchise lawyer Tony Wilson is the author of Buying A Franchise In Canada – Understanding and Negotiating Your Franchise Agreement and he is ranked as a leading Canadian franchise lawyer by LEXPERT. He is head of the Franchise Law Group at Boughton Law Corp. in Vancouver and acts for both franchisors and franchisees across Canada, many of whom are in the food services and hospitality industry. He is a registered Trademark Agent, an Adjunct Professor at Simon Fraser University and he also writes for Bartalk and Canadian Lawyer magazines.