Have you thought about starting your own business? More Canadians than ever are doing so. I’ve started separate small businesses both before and after filing for bankruptcy, but not during the time while I was actually an undischarged bankrupt. Recently I received this question:
“I live in Ontario and may be forced to file for personal bankruptcy due to a number of reasons. My question is, if I file for personal bankruptcy is it possible to start a small incorporated business while in bankruptcy for example either prior to filing or soon after?”
Good question! Without knowing more background details, or even what kind of business you plan on starting, it’s a bit difficult to give you a concise answer. The goal of this website is to provide hope and help for Canadians who have already been discharged from bankruptcy in Canada. But, since I have some experience in this, I’ll provide whatever assistance I can. However, if you are planning on filing for personal bankruptcy soon, I would highly recommend speaking to a trustee in bankruptcy for a consultation. Each case is different, and your trustee may or may not allow certain things.
Sole Proprietorship VS Incorporated
Starting an incorporated business (as opposed to a sole proprietorship), may make a difference. When I filed for bankruptcy in September 2007, I had to include all debts and assets of my sole proprietorship business in the bankruptcy. When you’re a sole proprietor, you are the business. You file your tax returns as one. When I went bankrupt, that was essentially the end of my business too. When a business is incorporated, it is its own entity. The business takes on a life of its own. A separate (corporate) tax return is filed for the business, and it costs quite a bit more than a personal or sole proprietor’s tax return.
So, if one was planning on declaring bankruptcy soon, an incorporated business would definitely be a better business model, not to mention other benefits of incorporating (which is beyond the scope of this website). However, if you are obtaining credit in the name of a new incorporated business, sometimes you are required to personally guarantee a loan or lease, providing your personal credit is strong enough. This will come back to haunt you when you file for personal bankruptcy.
Disadvantages of an newly incorporated business and personal bankruptcy
I would think it safe to assume you want to pay yourself a salary. After all, the idea behind starting a business is to make money, isn’t it? Again, you’ll want to speak with a trustee in bankruptcy as this is a bit of a gray area. Under normal circumstances, if you earn beyond a certain amount of money to sustain a reasonable (if not modest) lifestyle during the time you are an undischarged bankrupt, you are required to give anything over and above that to the trustee. That “surplus” is then distributed to your creditors. You may be better off getting a modest job and postpone your business start up. If this is your first bankruptcy, you can be discharged in just nine months. During those nine months, you can plan your new business and then register it the day you receive your discharge. That would be the safest way.
However, it may not be the easiest way! If you plan on securing any sort of credit, leasing an office, a car or equipment, you’re almost guaranteed to be declined with a fresh new bankruptcy appearing on your credit profile. But wait! We’re talking about an incorporated business, right? Yes we are. But I can’t think of any company that will be willing to extend credit to a brand new business with no established credit. They’ll want you to “cosign” or guarantee the loan. And you know what I think about cosigning!
Extending credit to a brand new business would be like extending credit to an 18 year old for a new car loan. Not likely to happen! Even though this may be a responsible teenager, most businesses aren’t willing to extend credit without a strong cosigner. The same goes with anything for a new business. Been there, done that. If you get credit in the name of your new business, it will probably be secured with your personal credit. And having a recent bankruptcy on your personal credit profile doesn’t help! During the 9 months when you are an undischarged bankrupt, you must ask permission from your trustee in bankruptcy if you must obtain any credit. Generally speaking, these requests are denied, as you are not supposed to have any credit during the time when you are an undischarged bankrupt.
Starting a business just before declaring bankruptcy
You’ll probably have to personally guarantee any credit before you file. If you financed (as opposed to leased) something like a car or equipment, you’ll probably lose it when you file for personal bankruptcy. There’s virtually no hope of getting credit during the nine months you’re an undischarged bankrupt. And once you’re newly discharged, nobody is going to want to extend credit to you personally, nor to a brand new business with no credit history.
If you don’t plan on obtaining any credit, that makes it simpler from a credit standpoint. Now you just need to clear it with your trustee, because after all, you’ll probably be on the “board of directors” so to speak and will personally benefit from any profit the business makes.
Starting a business just before declaring bankruptcy?
OK then, how about starting a business BEFORE filing for bankruptcy? The good news is that if your credit is still somewhat decent, you can probably qualify for an office or car lease which you will probably be able to keep during the bankruptcy. These will probably be in your personal name, or at least cosigned with you and your newly incorporated business. Providing payments are up to date, you are usually allowed to keep it and continue paying the lease payments during the bankruptcy. The theory being that there is no equity in a leased car. If it’s a financed car, you will probably lose it when you file for bankruptcy.
Business Credit may need to be secured with your Personal Credit
Everyone needs a place to live. A leased apartment or house should be fine as well. However if your new incorporated business leases office or commercial space for which you had to personally guarantee the credit, I’m uncertain as to whether the lease would be terminated due to the bankruptcy. Each bankruptcy is unique. Not to take the easy way out, but I don’t want to give incorrect advice, so you are highly advised to speak with a trustee in bankruptcy soon if you plan on incorporating a new business (and carrying on the business indefinitely) while declaring personal bankruptcy at the same time.
Again, you need to be careful of how much the business makes and how much you pay yourself or you may be required to give up anything over and above a modest income. If that’s the case, you might as well just get a modest job.
If you use your personal credit cards or line of credit and then file for personal bankruptcy very soon after (especially if you made some large, out-of-the-ordinary purchases) just before declaring personal bankruptcy, you can be sure that your case will be highly scrutinized. I’ve even heard unconfirmed reports that debts from these sort of purchases on credit may not be allowed to be included in the bankruptcy.
To Start or Not to Start a Business before Bankruptcy? The Verdict:
So what’s the verdict? Without knowing all of the background details, I would personally wait until the bankruptcy has been discharged. That’s what I did. I had a small business before and another one after bankruptcy, but not during bankruptcy. However, mine were sole proprietorships. Incorporating may provide you with a bit of a loophole or reprieve, but run your ideas past a trustee in bankruptcy who will consider the “big picture” and all supporting background details.
If you decide to start an incorporated business as soon as you are discharged, you can certainly conduct research, write up your business plan and other preparatory work so that you are ready to open for business as soon as you are discharged.
Bankruptcy aside, Other Drawbacks to starting a New Business
Not to discourage you from starting a business, because I’m an entrepreneur myself (although working as an employee at a job while running my small business part time). I’m sure you’ve all heard the statistics on how many small businesses fail. I like how Robert Kiyosaki puts it, something like “if 9 out of 10 businesses fail, I might as well get my first 9 out of the way now.” Some industries have a higher failure rate than others. So, keep this in mind too, when you are making your decision about starting a new business.
Sorry if I’ve put a damper on things. I just want to point out all of the good and the bad. Plus, without specific details, it’s hard to give specific answers. And as for starting an incorporated business just before filing for bankruptcy… personally I wouldn’t do it. I would wait until the bankruptcy is discharged. In the end it’s your decision, and your trustee is the one who should give you the final OK on it.