For many entrepreneurs who want to set up their own business, getting started includes digging deep into personal bank accounts and possibly taking on a second mortgage for start-up financing.

Even in a line of business that attracts many because start-up costs are relatively low, there are significant sums to spend on computers, software, office furniture, stationery and signage.  In addition to these hard costs, new business also face a decision on whether or not to invest in a social media profile and campaign.  As the business continues, the owner may have to continue to prime the pump with personal assets to cover employee salaries, rent and utilities.  There can also be personal salaries and dividends that the owner never withdraws from the company, in order to help it grow.

The money the owner puts into the company is usually recorded in the incorporated company’s books as a “shareholder’s loan”, with the owner perhaps being the major or only “shareholder”.

As economic times show continuing uncertainty, many owners may be wondering what happens to this loan if their business has severe financial difficulty.  Cash flow issues can arise due to no fault of the owner – possibly a slowing property market, a fire on the premises, a lawsuit or other disaster.  The company may be pushed into bankruptcy.

If this happens, however, the owner does not want to compound the loss of the business with the loss of personal savings and foregone income represented by the shareholder’s loan.  Normally, the owner would be treated at best as any other unsecured creditor, and this is often not a good place to be.  In the lineup to recover funds, the owner is likely to be behind the banks, who probably have insisted on some form of security before extending financing.  The owner will also be behind Canada Revenue Agency in some areas, such as source deductions (income taxes withheld, employee payments for Canada Pension, Employment Insurance and the like).  At the end of the day, there may not be much money, if any, to be divided on a pro-rata basis among the unsecured creditors, whether they be suppliers or shareholders.

How do you make sure you will be closer to the front of the line if some unforeseen financial disaster strikes your company?  Take a leaf from the playbook of banks and financial institutions, and secure your loans.

This involves preparing a relatively straightforward document, easily done by any competent business lawyer, with no need for large amounts of costly legal time to draft something specific for your case.

A general security agreement, properly registered under your province’s laws (in Ontario, it is the Personal Property Security Act), is usually sufficient documentation to secure your shareholder’s loan.  It is important to note that where banks and other financial institutions are secured creditors, they will generally insist that the shareholder’s loan be subordinate to their position – in other words, they make sure that they collect as much as possible of the money owed to them, first.

The registration of security in respect of a shareholder’s loan may not be effective if the bankruptcy occurs within one year of the registration.  As a result, the sooner you have your registration in place, the sooner it can start to protect you and your family in the event of a financial disaster occurs.  The amount of time and effort involved in taking this step is worth the peace of mind that you have as a result.  It means that if you do suffer a serious business reversal, you may be able to recover enough from the wreckage to keep safe your future and that of your family – and possibly have enough left over to start another business.

Bryan A. Tannenbaum, FCA, FCPA, FCIRP is a Partner in the Restructuring and Recovery Services group in the Toronto office of Collins Barrow.