Archive for the ‘Protecting your equity’ Category

Death can be sudden, or expected. Death fills us with grief at the loss of a friend or loved one. It can be very stressful for those of us who are charged with the highest of fiduciary duties – being the executor/executrix of an estate.

Your duties are:

  • Bury the dead! Make the arrangements with the undertaker as per the wishes of the deceased.
  • If the will is to be probated, prepare a list of assets and liabilities as of the date of death. This is given to a lawyer who will prepare this for presentation to the probate court. A fee is required.
  • Send copies of the death certificate to employers, pension providers, investment firms and creditors attesting to the death of the person and that you are appointed as estate representative.
  • Check for life insurance policies. Term life or whole life policies should be given copies of the death certificate. The funds (life insurance proceeds) are non taxable proceeds and are the property of the estate for which you are the fiduciary.
  • Make certain that the will you have is the latest will. (I assume that is another reason for having the estate probated as the will must be submitted with the estate holdings).
  • Arrange to dispose of personal assets in an orderly fashion.
  • The funeral director’s fee may be paid before the estate is settled. Check with the estate lawyer however.
  • Take a copy of the will and death certificate to the deceased individual’s bank. The account should be closed and any funds transferred to an estate account. Cheques should be printed in the name of: “The Estate of________”
  • A T1 return (terminal return) needs to be prepared up to the date of death.
  • Any income received post-death form part of the estate proceeds.
  • A T3 trust return for the period post-death to date of settlement of the estate must be prepared.
  • The income taxes due by both the individual and the estate needs to be assessed by the CRA before any beneficiaries can be paid and a TX19 Clearance Certificate issued.

This is a big job. Make sure you understand what you are getting into before you accept the appointment.





I guess the simple answer is: “Are you keen on buying or do you just want to know?” It is ironic that the net worth of self employed Canadians is largely un-calculated. The value of a proprietorship is essentially it’s goodwill. This means the net present value of its customer list. The value of shareholder equity can be calculated but some assumptions need to be made.

For a CCPC (Canadian Controlled Private Corporation) the shareholder equity section of the balance sheet is reported at book value only. One way to compute your net worth is to look at the “Cash Generated By Operating Activities” section of the Cash Flow Statement. You should go back 3-5 years. Your accountant can prepare this statement if it isn’t readily available. Now what?

The cash generated by operating activities is otherwise called your cash profit.  Then perform the following additions/subtractions to the cash profit:

  • Add back amortization (a non cash accrual)
  • Add back any accruals for income taxes (non cash accrual)
  • Deduct management (ownership) salaries and benefits.
  • Deduct family salaries and benefits (if you have family members in the business)
  • Deduct any other perqs that your business may cover for you.

The resulting (adjusted) cash flow from operations is (or should be) a larger number.

Do the same exercise back 3-5 years if you can.  Then average the adjusted cash profit.

This cash profit (average) is capitalized by 3x the average cash profit.

This is a fair valuation of your business equity.

It may be a surprisingly large figure. It should give you pause for reflection. Two queries should come to mind:

  1. How do I begin to monetize some of my net worth right now? Can I draw a dividend in lieu of a partial salary?
  2. How do I protect the equity in my business or pass it on to family members?

Good questions indeed.


Many small business entrepreneurs who I’ve met feel it is better to start out as a corporation rather than being a self employed proprietor. Their thinking is that they escape personal liability operating under a corporate veil. Let’s look at some factors to be considered before incorporating.

A corporation is a separate legal entity from the owner (ie the shareholder). If the corporation is a Canadian Controlled Private Corporation (CCPC) there is a very lucrative small business deduction of 17% from the 38% corporate tax rate. There are other small business deductions depending on the business sector. Provincial corporation taxing authorities offer small business deductions as well.  In an ideal world, an individual who is in the 45% marginal tax bracket, could take dividends in lieu of T4 salary income and be better off on an after-tax basis.

A corporation offers limited liability protection against trade creditors. The liability of the shareholder is limited to the extent of the amounts owed plus any damages that might be awarded in a civil litigation case. A prudent shareholder/owner would want insurance protection as well so this could be covered off in a strict downside situation.

The Canada Revenue Agency (CRA) can hold the shareholder/director personally liable for unpaid corporate remittances for: employee payroll remittances, harmonized sales tax (HST) remittances and corporation tax remittances. If a company has bank lending facilities (ie line of credit and term loans) the bank will require personal guarantees in the case of default.

The incorporation process can be costly but worth the effort if the business performs as planned.  The share structure must be carefully planned so a lawyer should be retained. Should you incorporate federally or provincially?

The year end of the corporation requires a T2 tax return and this should be prepared by a professional accountant. Depending on the type of financial statement required the exercise could cost the company between $1,000 to $5,000.

Plan before you incorporate.





The new arrival into the family business brings youth, new ideas and a certain amount of irreverance that is positive as long as it is controlled. There are some problems that will arise and I will discuss a few here:

  1. Do I have authority to go along with your expectations?  This is a critical issue. The boss may get annoyed that his son or daughter made a bad decision or took initiative without consent but there should have been clear expectations about protocols for decision making when hired.
  2. None of my ideas are ever taken seriously. This is a routine complaint. Inter-generational arguments center around this. The owner usually retorts by saying that “you need to spend more time understanding how this business operates.” The new respondent replies: ” Your tried and true methods have been in place for years and they don’t work.”
  3. What is my role in the business? This is a fair question. I used to ask myself this when I went through stretches where I questioned if I was of any value at all.

The incumbent(s) need to carefully plan a management apprenticeship program. It seems counter-intuitive since the newbie is already in management.  The seeds of discontent can be set in with feelings of marginalization. I’ve heard many new family members say: “I am nothing more than a glorified gofer.” Well run family businesses may start the new family member in the shipping department and have them work their way up through the various departments before they ever see their name on an office door.

The acid test however is having a financial investment in the business. If a new member buys in to the family business (literally) then the rules are different. There may not be the due diligence undertaken similar to a sale of an interest to an outsider. If a second (or third) generation family member invests dollars in the business, before the ink dries there should be clear articulation of duties, remuneration and eventual acquisition of more shares.

The rule then becomes caveat emptor.

Sadly this isn’t the case…

The formula is simple: Know your client + know how to make money = add to your net worth! It seems so simple doesn’t it? The businesses that make money on a year-over-year basis should have an amendment to this simple formula: monetizing your net worth.  This is the hard part.

I had a small business owner lament to me that: “I’ve invested about a hundred thousand dollars into this business and all I’ve done is bought myself a job.” How true!

Small business corporation shareholders receive a salary (and a T4 at year end) but I have seen only a couple receive T5s (investment income – specifically dividends).  Why not? Given that the sum of shareholder loans plus shareholder equity represents a large percentage of the total net worth of  shareholders,  why don’t shareholders integrate their payouts? (salary plus dividends).

It’s a good point. If a shareholder’s remuneration was $75K a year (in salary income) and it was changed to $50K in salary and $25K in dividends, the tax bite would be lower. The $25K is NOT earned income and as such would be excluded from contribution room to an RRSP but, seeing that a small business owner considers their business to be their RRSP,… well .. why not investigate the advantages of this remuneration split?

There must be sufficient equity to pay a dividend of course and no bank loan covenants preventing the declaration of dividends.

There must be billions of dollars tied up in the Shareholder Equity section of small business balance sheets across the country. This is the biggest dilemma facing baby boomers who own CCPCs and are trying to retire.

The old maxim holds: “.. use it or lose it.”


The investment in a corporation is comprised of:

  • Retained earnings
  • Shareholder loans

This can be a large dollar figure. Retained earnings acrete when net profits add to the opening year retained earnings balance in the shareholder equity section of the balance sheet. Shareholder equity is reduced  when a business incurs a loss.

An increasing retained earnings will improve business capitalization and make creditors (like your commercial bank) happy. The main issue that I have with retained earnings is that they are locked in a business. They can be paid to shareholders as a dividend but the business must (a) replace the dividends paid out my future earnings and (b) have the cash flow to pay the dividend.

Canadian households have a lot of net worth tied up in the equity in their homes. Many Canadians downsize – move from their home to a condo or apartment – as they age and the kids leave the nest. They monetize the wealth they accumulated over the previous 25-40 years. A small business corporation is a key line item on a personal balance sheet. The value of business equity can be estimated but the main problem remains: How do you monetize the equity in your business?

Releasing retained earnings should be a major focus for a shareholder of a small business corporation. How can I take a combination of salary and dividends to minimize my tax liability? If the business is not in a cash position to pay dividends, what steps should you take to get the business “dividend ready?”

A financial planner has models to restructure your investment portfolio such that preservation of capital and income (from your investments) goes to the forefront after 50.

Why isn’t this done with retained earnings?





The risk a small company carries on its balance sheet isn’t too hard to determine. A publicly traded company has its risk measured by a “beta” calculation. A publicly traded company with a beta of 1.5 means that the market price of the company stock will usually fluctuate at 1.5x the market fluctuation. The beta attributed could be the result of observed fluctuations (ie “technical factors”) as well as possibly the volatility of certain sectors to possible interest rate changes.

The “beta” of  a small privately held company is a “fundamental” factor. My own definition of beta is:   the ratio of outsider capital/insider capital where:

  • Outsider capital is: accounts payable and accruals plus statutory remittances plus term loans and mortgages
  • Insider capital is: shareholder loans plus shareholder equity.

This ratio shouldn’t be more than about 1.3:1; $1.30 in outside capital to $1.00 of inside capital. The higher the ratio (ie. the higher the beta) the greater the risks for the business. There are a number of risks that escalate given a high beta:

  • Business risk – the ability of the business to continue or get interest free funding.
  • Interest rate risk – as interest rates rise, credit limits become strictly enforced and banks tighten up on lending
  • Financial risk – the risk that the business may fail.
  • Foreign exchange risk – the risk to the business of currency fluctuations
  • Market specific risk – being a service industry in a one industry community.

It is easy to see that while outside capital may not change too much over a fiscal year, if the company incurs operating losses, the loss reduces the denominator and increases beta.

Beta is a real indicator of conditions that occur regularly in smaller companies. Any business operating “payroll-to-payroll” and stringing out creditors is over-extended and over-levered. A drop in revenue could cause the business to fail.

Many small businesses are severely under-capitalized.  Simply put – beta is at unacceptably high levels. Lenders look at balance sheets for this ratio. You should know what your “beta” is and have a strategy to reduce risks.

How does your business score in the following key metrics?

  1. Has been profitable for the past 5 years?  ( 1 point for each year).
  2. Your business has a budget and has been on budget for the past 3 years? ( 5 points for each year)
  3. If your business is incorporated, does the business have “key man” insurance? (5 points for yes)
  4. If you employ staff, do you appraise their work annually? (5 points for yes and 0 for no)
  5. Do you have an exit strategy from your business or a contingency plan in the event of your death or debilitating injury? ( 5 points for yes and 0 for no).
  6. For corporate small business owners, do you know what your business is worth? ( 5 points for yes and 0 for no).
  7. If you have a will give yourself 5 points. If it has been updated in the past 5 years give yourself an additional 5 points.

The perfect score is 50 points. All shareholders of small businesses should carefully consider their scores in each of the 7 categories.

What is your course of action to correct the scores in any of the questions where your business falls short?