Transcript PB4L—Personal Business For Life: Real Estate Examples

Creditor Proofing
And Organizational Structure
For Entrepreneurs
By Professor Bruce M. Firestone, B.Eng. (Civil),
M.Eng.-Sci., PhD., Entrepreneur-in-Residence,
Telfer School of Management, University of Ottawa;
Executive Director, Exploriem.org; Founder, Ottawa
Senators; Real Estate Broker and Mortgage Broker,
Century 21 Explorer Realty Inc., Brokerage
Creditor Proofing
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Bankruptcy trustees, supposed to give
someone in trouble impartial advice,
Influenced by fact that if you decide to go
bankrupt, that’s a new customer for them
Banks and financial institutions are unlikely to
be your friend in need
Call your loan immediately—so they can be
first in line to grab your assets
Creditor Proofing
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Really no such thing as ‘Creditor Proofing
Putting money in secret overseas, numbered
bank accounts, protected by bank nondisclosure laws in neutral countries like
Switzerland or ‘pirate’ havens in the
Caribbean—bad idea
Neal Stephenson, Cryptonimocon, describes
data havens
Nothing is private or secret any longer
Creditor Proofing
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Ken MacMillan, old fashioned guy
Thought best way to creditor proof yourself
was to not have any creditors
Paid his bills on time
Lived within his means
Saved money every month
Paid cash for his home and only purchased
what he could afford
Creditor Proofing
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When Ken passed away, estate attracted no
death duties or terminal tax liability because
he kept all of his money in cash
No deemed disposition of stocks, RRSPs,
property (other than his primary residence,
which is tax free in Canada anyway)
Canada Revenue Agency (CRA, equivalent of
IRS in US) didn’t take away half of his estate
There were no lawyers and accountants
involved to take away other half
Creditor Proofing
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Father-in-law did not think much of me
Built real estate empire and then a NHL
hockey franchise with huge land assembly
Largely with debt
He was not impressed
Creditor Proofing
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Late Harold Shenkman, Founder of Shenkman
Corporation, large real estate holding
company in Ottawa once told me that:
“…the way I kept a good relationship with my
Bank (the Royal Bank of Canada) for over 40
years, Bruce, is that they always owed me
money.”
Creditor Proofing
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Billy asked me what I was going to do when I
got into business in 1982
Told him I was going to build office buildings
Billy said he was going into parking lots
At the time, parking in downtown Ottawa was
about $25/month
Office rents in western suburbs were ~ $18
per square foot triple net
By 1987, parking rates were around
$80/month while office rents down to 6 bucks
Creditor Proofing
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In 2000, went to my Bank to see mutual funds
were doing
Gave them $100,000 in cash in 1995 to invest
in their Bank mutual funds
Supposed to receive a monthly statement–
never got a single one
In greatest bull market since 19th century RR
bubble, they turned $100k into $90k
Creditor Proofing
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Bank’s mutual funds were among 10% worstperforming mutual funds in Canada
Managed to lose compounded average of 2.5%
per annum for 5 years
Monkey throwing darts at list of Canadian
mutual funds would have done better
Creditor Proofing
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How to Get in Trouble?
• you do not pay off your credit card balances every
month;
• you receive multiple applications for other credit
cards in the mail and you complete these and get
those cards too;
• you miss payments;
• your bank lines are maxed out;
• you bounce a few cheques by mistake;
• you can’t keep track of all the payments you have to
make;
Creditor Proofing
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How to Get in Trouble?
• creditors start calling your house;
• your spouse goes out to buy an appliance
on OAC (On Approved Credit) and she is
rejected because your credit rating (measured
by your Beacon score) has fallen below 650 or
600;
• your bank calls your personal loans;
• you can’t get another mortgage on your
house;
Creditor Proofing
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How to Get in Trouble?
• your bank wants you to change your Line of
Credit into a term loan so you pay it off and
then they won’t renew it;
• you need to go to private lenders for loans
at much higher than prime lending rates.;
• you can’t get any new financing at all.
Creditor Proofing
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Causes?
• drinking/drugs/gambling;
• job loss/divorce/illness;
• failed biz model/entry of new competitor;
• inadequate sales;
• receivables age– major client goes bankrupt;
• insurance claim disallowed (Bora Laskin);
• fail to control costs;
• loss of hope…
Creditor Proofing
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Refi your personal residence?
• drive-by appraisal;
• FMV, fair market value;
• LTV, loan to value ratio;
• QSV, quick sale value;
• 48 hour refi;
• or leg breaker loans.
Creditor Proofing
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Human beings cannot live without hope
Three days to recover
First, to be angry at the world
Second, to feel sorry for yourself
Third, get some exercise and get on with rest
of your life!
Creditor Proofing
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Personal Bankruptcy Option
US execs proud to tell stories of companies in
financial difficulties turned around by taking
them into Chapter 11
Not same as personal bankruptcy
many things you can not do: teach, police
officer, security clearance, get credit card, get
cell phone, visit some countries, be Director
or Officer of publicly traded company, be an
Accountant, buy on credit, get mortgage...
Creditor Proofing
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Get complete discharge from bankruptcy after
a few years or even months and your record
wiped clean?
Total bunk—data havens
Personal bankruptcy, you end up paying three
times!
Creditor Proofing
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First, you pay court appointed Bankruptcy
Trustee to manage your affairs (you have new
boss)
Second, not discharged from some of your
responsibilities (like, alimony) or Judge may
decide you have good earning potential/put
future earnings in pot for your creditors
Thirdly, you’ll pay higher costs for everything–
no OAC for you!
Creditor Proofing
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How to Get out of Creditor Hell?
If you drink too much, stop!
Terry Matthews takes 7 to 12 years to build
great business/hard work and focus required
So it’ll take you and me longer!
Lower your costs
Fortune 100 corporation CEO could not
control his costs– collecting grand masters
Creditor Proofing
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Control Costs?
• reducing the number of phone lines you
have,
• having a home office instead of a plush
downtown office,
• doing our own filing instead of hiring a
clerk,
• answering your own phones,
• sending your kids to public school instead
of private school,
Creditor Proofing
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Control Costs?
• taking a nice GoTravelDirect.com holiday to an all
expenses inclusive resort in the DR for $899 a person
including airfare instead of staying at the Kahala
Mandarin Oriental Hotel in Waikiki,
• visiting a qualified, trusted Mortgage Broker and
renegotiating your home mortgage interest rate,
• visiting a qualified, trusted Mortgage Broker and
increasing your home mortgage in order to pay off
high interest rate credit card balances,
Creditor Proofing
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Control Costs?
• freezing your credit cards,
• selling your home and downsizing,
• turning off lights in your home,
• lowering the thermostat,
• getting rid of premium cable services,
• getting rid of cable,
Creditor Proofing
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Control Costs?
• reducing the number of dinners out,
• brown bagging your lunch,
• planning your day to become more efficient with
your vehicles,
• buying gas when it’s cheap,
• maintaining your vehicles so they last longer—doing
preventive things like remembering to change the oil
once in a while,
• doing minor house repairs and routine maintenance
yourself…
Creditor Proofing
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Raise Revenues?
• Can I ask my boss for a raise?
• Should I look for a higher paying job?
• Is there anything else I can sell?
• Should my spouse take a job outside the
home?
• Can I start a business that will make us
more money?
Creditor Proofing
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Raise Revenues?
• Should I get a second job?
• Can I add to our income by doing some
consulting?
• Can I make more money by stopping some
of the things I am doing and concentrating on
the best opportunities? (My Dad called this
‘supporting the winners and dumping the
losers’.)
Creditor Proofing
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Whatever you do, don’t ignore your creditors
They hate that
Will definitely report you to credit bureau
Kill your credit rating
Be polite, tell them what steps you are taking
to pay them (even if you are late) and then live
up to what you said you would do
Creditor Proofing
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Terrace Investments Ltd policy of not kicking tenants
out when they had financial problem
Not suing them either
Lower rent by agreement during tough times and get
it back during better times
“If a man should steal my watch, I shall fight him for
it. But if a man should sue me for it, I shall take it off
and give it him, glad to have gotten away so cheaply.”
Creditor Proofing
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If you are honest with people, most of them
will cut you some slack
Error of omission versus commission
“It is the definition of insanity to repeat the
same things over and over again and expect a
different result,” Anon.
Creditor Proofing
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What to do if You or Your Company is
Petitioned into Bankruptcy?
Fight it, especially if it’s personal bankruptcy
If vindictive creditor just wants to hurt you,
they may try to petition you into bankruptcy
You don’t have to accept that
Creditor Proofing
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Meeting face to face with your most difficult
creditors is generally a good idea—they see
that you are not such a bad person after all
Lawyers don’t want to settle– you do
Is it any surprise that NHL experienced a yearlong lockout when NHL and NHLPA were both
led by lawyers? Gary Bettman and Bob
Goodenow
Creditor Proofing
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If you or your company do go bankrupt– tell
the truth
The smart truth
Coke’s soda pop dispensing machine that
increased prices when temp increased…
In our society when things go wrong, we
always want to find someone to blame
And that someone is you
Creditor Proofing
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• Call the Trustee the next day and arrange for him to
send you a list of questions that he needs help with.
• Take the initiative.
• Offer to help.
• However, never answer their questions off the top of
your head.
• They have done this dozens, maybe hundreds of
times and they know how to think around corners.
You have done this (hopefully) never. Therefore, it is a
very unequal playing field and likely to result in a very
unequal result.
Creditor Proofing
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• Remind yourself that they are not your friends.
• Remind yourself that they may be trying to trap you
into saying things that incriminate you even though
you have done nothing wrong.
• Answer their questions on paper first. Then sit on
your answers for at least 24 hours.
• Read them again. See if they still make sense.
• If you can’t handle it yourself, get a lawyer.
Creditor Proofing
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• Don’t get bullied or rushed into premature answers.
Tell them you’re trying as hard as you can to get all
the info they need.
• Start by giving them something innocuous to show
that you are cooperating and this will buy you some
time.
• Remember what happened to Patty Hearst—she not
only got captured by the Symbionese Liberation Army,
she was brainwashed into becoming a gang member.
This is known as the Stockholm Syndrome, which
means that any of us can be forced to do things we
would normally abhor if we are under sufficient
duress.
Creditor Proofing
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• If people keep telling you, you are a bad person, you
may eventually come to agree with them even if you
did nothing wrong. (This entire essay is based on the
fact that you are a trustworthy person trying to get
ahead honestly in the world but, like everyone else on
the planet, you make mistakes of omission.)
• This is what Crown Attorneys (District Attorneys in
the US) count on in a cross-examination—that they
can brow beat and rush you into damaging
admissions. Even experienced, professional witnesses
feel intense stress during these types of crosses.
Creditor Proofing
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• You would be surprised what people will admit to—
even things they did not do just to get them to stop.
• You never let people like this put words into your
mouth. Don’t repeat bait words like: “Isn’t it true Mr.
Smith that you paid bribes to City officials to get your
permits released?” You don’t answer: “I never paid
bribes” because the next question will be: “Well, Mr.
Smith, if you don’t like the word ‘bribe’, what word
would you use?” You can see where this might take
you. The smart answer is: “We have records and
invoices from the City for all of the costs for our
building permits.” The word ‘bribe’ never passes your
lips.
Creditor Proofing
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• Remember the ‘pen is a long arm from the
grave’. Never write anything down that you
would not feel comfortable seeing on the
FRONT page of your local newspaper.
• This goes for email too.
• Especially for email.
Creditor Proofing
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Your Credit Rating
If you owe money to IRS or CRA, this is
serious
CRA can get an ex parte judgment against
you—they can get judgment against you
without you being in court or even being
notified of fact that legal proceeding is taking
place
Atrocious
Creditor Proofing
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With judgment against you, they now have
power to ruin your credit rating
To send bailiff in without notice
To garnishee your wages
To seize any property you have and much
more…
Creditor Proofing
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Credit rating torpedoed?
You’re sunk
No OAC
Credit bureaus are hugely powerful
Keep track of all credit cards, mortgages,
Bank debt…
Even number of requests made on your credit
rating lowers Beacon Score
Creditor Proofing
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Absolute right to demand from each credit
bureau, free copy of your credit report
Check it!
SMEE owner had his credit score cratered
when Bank held certified cheque and bounced
all his payments
Creditor Proofing
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The Proper Role of Debt
Recommend to students buy their own home,
condo, townhouse, as soon as they can
To do that, most need mortgage
Mortgage can be a form of useful debt
How many can save $700 a month? None
How many can afford $700 a month in rent?
All
So why not buy a home?
Creditor Proofing
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Part of every month’s blended mortgage
payment pays off principal
Over time  mortgage-free home
Forced savings
Home equity is world no. 1 source of startup
capital
Wealth effect– imputed rent
Creditor Proofing
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Way to understand imputed rent is as follows:
1. You own a home free and clear.
2. You decide to move out and rent your home out for $2,000
per month.
3. But you need to live somewhere, so you rent a comparable
home for $2,000 per month.
4. Your former principal residence (now a rental property) is
producing income for you and let’s just assume you net $24k
a year (i.e., your costs are zero).
5. However, you are in the 50% marginal tax bracket, so you
have to send CRA half of this amount—you are left with $12k
after tax.
6. But you are paying rent of $24k a year to your Landlord so
you are out $12,000 in CASH.
7. Therefore, you are $12,000 better off staying in your
principal residence. This is a very real effect* if somewhat
hard to grasp.
Creditor Proofing
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Not all debt is bad
But buying NHL hockey team with debt is
probably bad idea
Good debt is secured debt so that, if for some
reason you can’t make your payments, when
you sell the underlying asset, the debt goes
away
Good debt is that it is secured by an asset
whose value is likely to exceed the
unamortized portion of your debt throughout
its term (i.e., probably not car loan)
Creditor Proofing
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Bad debt unsecured personal debt where only
recourse is to you–credit card debt and
student loans, for example
Note: can be upside down on equity in your
home in hurry if market crashes as it did in
parts of the US in 2008/09 when home prices
collapsed in Florida, Arizona and California by
as much as 50%
Good debt may also be debt that creates
return on investment
Creditor Proofing
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How to Reduce Your Risks and Protect Your
Family?
Don’t protect your family by hiding your
assets on Pirate Island
Don’t be financial engineer
Never buy an asset to lose money so you save
taxes!
“Be proud to pay your taxes in a great country
like Canada, but don’t pay more than you
have to.”
Creditor Proofing
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Free to arrange your affairs in a way that is
efficient and effective, as long as it meets
GAAP (Generally Accepted Accounting
Principles)
Keep your affairs simple
LLC—Limited Liability Company.
Apart from a few institutions that are ‘other
directed’ (like the Holy Roman Catholic
Church, The Emperor of Japan or the House of
Windsor), longest lived organizations on
planet are incorporated companies
Creditor Proofing
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LLC limits some but not all of your personal
liability
In Ontario, Directors and Officers may be held
personally liable for environmental
contamination or non-fulfillment of statutory
obligations like remitting HST (Harmonized
Sales Taxes), PST, PAT, income source
deductions
In order to avoid such personal liability,
Directors must show they have been duly
diligent
Creditor Proofing
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Incorporate personal holding company (PHC)
Put your assets in there except for principal
residence
In Canada you can sell your principal
residence tax free, so it should not go into
PHC
Principal residence should go into spouse’s
name—spouse with lowest risk profile
Creditor Proofing
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In Ontario, if you get divorced, half of
everything you own goes to your partner and
vice versa
Don’t pledge your house to secure loans if
you can avoid it
Try to pay off your mortgage as soon as you
can
Creditors (in Canada) can get at your RRSPs,
so make sure you max out your spouse’s
before your own
Creditor Proofing
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Some types of insurance-based products
(e.g., seg funds) are creditor proof in Canada
Individual Pension Plan (IPP) is defined benefit
registered pension plan that a company
contributes to on behalf of owner
manager/employee
Contributions are tax deductible to company
and non taxable to owner/manager
plan must be registered with Canada Revenue
Agency and is fully creditor protected since it
is bona fide pension plan
Creditor Proofing
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You own small percentage of your PHC
Spouse and kids own majority
If you get in trouble, PHC may not go down
drain with you
If you own only a nominal shareholding in
PHC, upon your passing, taxes on deemed
disposition of your assets will be minimal
Companies can live forever, you won’t
Creditor Proofing
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If you have home office for your PHC, some of
costs of running your home may be tax
deductible
Inter-corporate dividends between two
Canadian companies may be tax-free
So you can find efficient ways to get money
into PHC and out of PHC into hands of
yourself and your family
Creditor Proofing
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You or your spouse or both might become
consultants to your PHC
Your PHC might be a consultant to your
clients or other companies
Often first step toward full-on
entrepreneurship is to turn yourself into
consultant instead of employee
Creditor Proofing
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Your PHC owns shares in your op co and in
your real estate co
Your op co rents from your real estate co at
FMV
Move profits to real estate co and up from
their via inter-corporate dividends
Capital dividend account create opportunity to
dividend out, tax free to shareholders of PHC
including you, your spouse, your kids
Creditor Proofing
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Diversify!
Buy a home (townhome or condo) as your
principal residence and pay off your mortgage
Buy some residential rental property with 5%
down
Buy some commercial rental property with
25% down
Buy some land with 50% down
Creditor Proofing
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Diversify!
Set up a PHC
Have an operating company, a PB4L
Have an iron reserve
Have some financial assets
Manage your assets and manage yourself!
@ProfBruce