Roger Granger* faces a health crisis that could ruin his budding business and his son’s financial future. We spoke with three experts to determine his options.
Mark Granger is 30 and works in corporate public relations in Toronto. He earns $78,000 yearly and rents a condo with carrying costs of $1,400 a month. He lives alone, but his longtime girlfriend, Tina, is planning to move in with him.
His 58-year-old father, Roger, is a serial entrepreneurial failure whose latest venture, a software company in Tisdale, Sask. that produces mobile apps, shows more signs of success than past tries—finally. Mark is an only child and his mother died three years ago. He’s remained close to his father and even done some pro bono marketing work to help his dad’s firm control costs.
Mark co-signed on a $500,000 business loan for his father three years ago. The infusion of capital helped, and the company is on the brink of profit. His dad’s been meeting all loan servicing costs to date, but the loan still has seven years left on its term (so most of the payments so far have gone to interest). The loan rate is 5.6% and there’s still $390,000 in principal remaining to be paid.
Last month, Roger went through a battery of medical tests after complaining of stomach cramps. The result was a diagnosis of stage 3 pancreatic cancer, for which there’s a low five-year survival rate. His doctor has advised him to prepare for the worst, and to stop working as soon as possible so that the treatments will have the best chance
Roger is very concerned about the residual costs of his business loan ruining his son financially. At one point, he owned a house but lost it after putting it up as collateral on loans for a prior, now failed, business. He now rents a small apartment, which is suited to his workaholic lifestyle.
Roger declared personal bankruptcy once before, in 2005, and has no other assets, having cashed out a UL policy with $64,567 in accumulated value to meet business debts 15 years ago. He is drawing a take-home salary of $2,400 monthly from his company—which covers his expenses in the rural hamlet of Tisdale but leaves little left over.
He’s appealed to Mark to leave Toronto and take over the business, certain that his youth and energy is what’s needed to push the firm to profitability. Mark, having grown up in a whirlpool of economic uncertainty sparked by what he views as his father’s refusal to get a real job, has announced that won’t happen.
Still, he’s worried for his father and afraid of how the remainder of the loan he’s co-signed could potentially wreck his financial future.
The company has developed some popular apps, but they are niche products and wouldn’t have any significant sale value to a competitor.
Its status as a startup that’s not yet profitable makes it difficult to value. However, two of the young software engineers working there have expressed interest in making a provisional offer that would include taking over the debt based on existing cashflow for apps in field. With four more potential moneymakers on the drawing board and close to launch, Roger is reluctant to consider this offer.
But he also doesn’t want his son to inherit his debts, and the co-signed loan is, unfortunately, one of the few vehicles that can allow that to happen.
Sharon E. Duguid: Roger is having what we like to call a trigger event. These are events with a life-changing impact—a stroke, divorce, or unexpected illness like cancer.
Many business owners don’t plan for these possibilities, or they don’t do the right planning.
That can leave them with few options, and this is the situation Roger’s in.
Kim Moody: That’s why I always suggest critical illness insurance for clients who are starting a business, and who will rely on it for all their income. If all of a sudden the client gets cancer and can’t support himself, at least he has a sustainable source of cash that can either pay for treatments or replace lost income.
SD: Also, when Roger took out the $500,000 loan, he should’ve bought life insurance. This would protect Mark from the debt in the event of Roger’s death. That’s no longer an option.
Next steps: Keep or sell the business?
SD: Roger seems to want to keep hanging on because he thinks he’s on the verge of major success.
But he needs to think about his legacy and be responsible to his son. He should consider every avenue to sell. If he has an offer from within the company, he should take it.
KM: Agreed. If I’m Roger, I care about the financial state of my son. I’d be looking to unload the business, even if there’s potential for significant upside. You can bet that if Roger dies, the bank will demand repayment. First they’ll go for the company; then they’ll come to Mark.
SD: And Roger should definitely get a second opinion on his cancer. It’s possible his doctor is wrong and he could live well past five years. But, assuming he dies within five years, there needs to be a frank conversation about what Mark’s willing to do. It’s clear he feels bad for his dad, but there’s a question around how much he’s willing to help.
It seems Mark doesn’t want the business, which opens up a couple of issues: the value of a future sale, and of the intellectual property. Roger could probably leave the intellectual property to Mark as part of his estate.
The two software engineer employees interested in buying the company are Roger’s best bet if he sells. It’s questionable whether the engineers would buy the company without the intellectual property. And they sound a bit naïve. It seems they’ve drunk the Kool Aid and it just might be Roger’s way out of this situation. If they buy the company, he transfers all the risk to them; but they’re young and they can recoup their losses if it’s a flop.
KM: On the other hand, they will probably know Roger’s in a desperate spot because of his health. They’ll probably put the screws to him on price and terms.
SD: Also, licencing agreements could create future cash flow for Roger if he survives or if he wants to pass it along to Mark.
KM: Royalties on the intellectual property would be fully taxable as ordinary income.
SD: Still, Roger’s number one priority should be clearing up his debt, and that means he should sell the business. But it’s hard to value a company that hasn’t gone live. I don’t expect anyone would want to buy it broken up app by app, so selling it whole is the most likely outcome.
I’d evaluate the offer with the help of people I know in the software business. I recently had a potential client come to me with a software app for gambling. He wants to sell it so I ran it by a friend of mine, who has the second most successful online gaming company in Canada. He said he wouldn’t offer more than $50,000. The potential client thought it was worth $1.2 to $2.5 million, based on sales projections.
If Mark’s willing to reconsider involvement in the business, Roger might want to structure the sale so Mark is a one-third shareholder with the engineers until profit’s grown enough to pay off the loan. But I still think the best thing to do is sell outright.
If Roger dies, Mark will have to handle the sale. The bank may help, but in that case it would be a fire sale. Depending on how big the debt is, and what the market is [like], the bank will take first offers. It’s like selling a house that’s gone into receivership.
Read: Don’t delay planning
KM: You can be sure the bank will never forgive that loan, and bankruptcy may be an option for Mark if Roger dies and there’s little sale value for the business. He would need legal advice.
SD: Another option for Roger is to have a business consultancy handle all aspects of the sale. Someone selling a business needs a broker with access to people with money, like investor groups, and these firms have large networks they can tap. There’s a cost, of course, but they do a professional valuation, work with banks, and structure an agreement that makes sense.
In this case, the firm might tell Roger they’ve arranged a deal for $150,000 up front, with the buyer agreeing to buy the debt and pay it down over a five-year period. The consulting firm would handle negotiations with the bank.
The problem in a case like this would be convincing Roger to accept the deal. He might think the company’s worth $2 million, but he’s not in a position to get what he wants.
Everything depends on the valuation and the key there is what kind of potential the company’s seen to have. That process would definitely involve a specialist who knows the apps market.
KM: Tax certainly isn’t Roger’s biggest worry right now, but how much he pays if he sells the company depends on how he structured the business. If it’s a corporation, there’s potential to dispose of it in a tax-preferential manner. The capital gains deduction could allow him up to $800,000 tax-free on the sale of the shares. But there are a number of conditions. If the business is going to be sold piecemeal it doesn’t work.
He has to have held the shares for two years or more, and they must be qualified small business corporation shares. Also, his cumulative investment income has to be greater than his cumulative investment losses since 1988.
That’s what’s referred to as a Cumulative Net Investment Loss (CNIL) account. Given that Roger’s been a bit of a failure, if he’s ever claimed certain types of losses, and Allowable Business Investment Losses (ABIL) in particular, he won’t be eligible to claim the capital gains deduction up to those ABIL amounts that he’s claimed. So those are the personal tests from a very high level. On the corporate level, 90% or more of the assets have to be utilized in an active business at the time of disposition. If Roger’s business is struggling, I’m guessing it would meet this requirement. Additionally, for the previous 24 months, more than 50% of the assets had to have been utilized in an active business. Even if he can’t claim the capital gains deduction, if he sells his shares of the company he’ll end up paying capital gains rates. For a resident of Saskatchewan, that means roughly 22% on the high side.
If the business is unincorporated, he’s essentially selling the assets. If he’s selling the intellectual property, it could be half taxable at 22%. But you’d really have to get a handle on exactly what he’s selling, and the tax results will drive from there. If there are patents, they could be fully taxable, which in Saskatchewan means 44% on the high side.
SD: I would sit down with Roger and Mark separately. I’d hash out what’s palatable for Mark, then for Roger. I’d gauge Mark’s comfort level with the debt, and any possible responsibility for
They also need to discuss who’s going to take care of Roger. He lives in Saskatchewan, while Mark’s in Ontario. Mark could end up saying he wants Roger to sell the business, move to Toronto and hire a full-time caregiver.
Our greatest fears are not to be loved and dying alone. People do a lot of stupid things to avoid both. Roger may think he can earn Mark’s love if he can leave him a $5-million company. Mark and Roger probably have different objectives: Roger wants a successful business and Mark wants to see his dad be as healthy as possible, for as long as possible.
*This is a hypothetical client. Any resemblance to real persons, living or dead, is purely coincidental.
Don’t marry debt
Katherine Cooligan, partner and manager of the Ottawa Litigation Department of Borden Ladner Gervais LLP, weighs in on Tina’s options.
Tina has to ensure she doesn’t walk into a $390,000 debt. If she moves in with Mark and they become common-law spouses, she doesn’t have to worry. That’s because in Ontario, common-law partners don’t have the same property rights as married couples.
If she marries Mark, it doesn’t mean she has legal responsibility for his debt. Problems would arise with separation. If that happens, the couple’s assets are equalized based on net family property. Under Ontario family law, neither member of the couple can have a net asset value less than zero. So, even if Roger dies and Mark’s saddled with the debt, his side of the equalization calculation would show a value of zero.
Let’s say Tina has a pension and savings totalling $200,000. Separation would mean $100,000 goes to Mark. If they stay common law, that wouldn’t happen. So my advice to Tina is either don’t get married, or if you marry, have a marriage contract that says you and Mark are separate when it comes to property.
These agreements are usually difficult for couples to discuss. But in a situation like this, it’s different. I could see Mark taking the initiative to draw up a contract protecting Tina from debt problems inherited from his father. If he’s a decent guy, he wouldn’t want to put her through that.
If Mark takes ownership of the company and it’s profitable, he would want a marriage contract. Right now, he has nothing to protect.
Dean DiSpalatro is senior editor of Advisor Group.