By Doug Hoyes
I took my family on a short vacation to New York City this summer, and we had the sense that Donald Trump’s name is everywhere. There’s the Trump Tower, and more than one Trump hotel. I even saw the Trump name on an airplane at the airport. So how can this guy be so successful, with his name on buildings, when he is also a survivor of four bankruptcy filings?
One answer is that Donald Trump has never filed personal bankruptcy. From 1991 through 2009, corporations that he was associated with filed corporate bankruptcy, primarily as a result of too much debt in his hotel and casino properties in Atlantic City.
The second answer is that, other than in his first corporate bankruptcy — where he personally guaranteed some of the corporate debt — his personal wealth was not involved. A corporation is a separate legal entity, so a corporation going bankrupt does not automatically impact the personal assets of its shareholders.
So what lessons can we learn from Donald Trump’s corporate bankruptcies?
Lesson No. 1: Stuff Happens
The first lesson is “stuff happens.” Obviously Mr. Trump made mistakes, and had excessive debt, which is always a factor in every bankruptcy. As a real estate developer, it’s common practice to borrow to finance the construction and operation of your buildings. The trick, of course, is to borrow just enough, but not too much. He borrowed too much. However, despite that, bankruptcy was not the end of his business career.
That’s perhaps the most important point: bankruptcy is not the end. It’s a strategy for eliminating debt, but in Mr. Trump’s case he was obviously able to convince lenders that his new companies had profit potential, and they were willing to do business with him many times in the future.
If you, or your company, has debt, you should attempt to pay it back. But if that debt is overwhelming, bankruptcy may be an option and you should not avoid it for fear that you will never be able to borrow again. Donald Trump proves that there is life after bankruptcy.
Lesson No. 2: There Is a Big Difference Between Corporate and Personal Debt
The next important lesson is that there is a difference between corporate and personal debt. In his first corporate bankruptcy Mr. Trump also suffered personally because he had personally guaranteed the corporate debt. That was a “mistake” he only made once. In his last three corporate bankruptcies, he did not personally guarantee the corporate debt, so he himself was not on the hook for any of the corporate debt.
That’s a very key planning point: Where possible, use a corporation to shield you from personal liability.
For example, if you operate a small business and need to sign a lease for your retail store, manufacturing facility, or office space, if possible sign the lease via your corporation, not personally. It’s very common for businesses to set up a separate numbered company (which is just a simple corporation with no name, just a number) and to use that corporation to sign the lease.
Why? Most commercial landlords want long-term leases, such as a minimum of five years. If for some reason the business fails and you must walk away from the premises, you want the corporation to be liable for the remaining rent, not you personally. By having a corporation that just rents the premises and does nothing else, your operating corporation, and you personally, are shielded from liability.
Of course, life isn’t that simple. Landlords knows this trick and will want you to sign personally so they are protected; so you will have to be a good negotiator to get what you want. If the landlord isn’t willing to accept your terms, you may want to look for another place to rent. Or, if this location is very important, perhaps you only agree to a limited personal guarantee, such as personally guaranteeing only the first year of the lease payments.
A Lesson on Liability
Limited liability is perhaps the main reason that most corporations exist, so let’s delve a bit deeper into the murky world of corporations.
You can think of a corporation as a separate legal entity (like a separate person). If that “separate person” is unable to pay its debts, it can go bankrupt — and that bankruptcy only directly impacts that separate corporation, without directly impacting the shareholders.
So, if you operate a business, it may be wise to operate it through a corporation that you control. It is then the corporation that enters into contracts (like leases), and the corporation assumes the risk of any loss.
So why doesn’t everyone operate every business through a corporation? Simple: Starting and operating a corporation costs money.
You have to pay to incorporate a business. It is theoretically possible to do it yourself, but in most cases the prudent approach is to have a corporate lawyer set it up for you. A competent lawyer can ensure that all of the paperwork is filed correctly and they can also create shareholder agreements and other necessary documentation. Since a corporation is designed to protect you, you want to set it up correctly.
Once the corporation is set up, you conduct all of your business through the corporation. If the business is successful, great — you can pay yourself dividends, or a salary, or whatever is appropriate.
If the corporation isn’t successful, and perhaps is forced to go bankrupt, you lose all corporate assets, but your personal liability is limited to what you have personally guaranteed, as well as your investment into the company. That’s why Donald Trump’s corporations can go bankrupt and leave him unscathed.
Again, this is not as simple as it may appear. You want to lease a photocopier? The lessor may ask for your personal guarantee. The company needs a bank operating loan? No problem, but the bank will probably also want you to sign personally as the guarantor. If the corporation can’t pay, you are still liable for the loan, so a corporation only protects you if you don’t also sign personally.
It’s a common “rule of thumb” that four out of five businesses fail within the first five years. Stuff happens. Sometimes bankruptcy is the result. However, as Donald Trump has proven — four times — a corporate bankruptcy is not the end of your business career. So get the advice of a competent accountant and lawyer when setting up your business so that you are prepared for whatever may happen to your business.
Doug Hoyes has extensive experience resolving financial issues for Canadian citizens. A Licensed Bankruptcy Trustee and co-founder of Hoyes, Michalos & Associates, he is also a Chartered Professional Accountant (CPA), Chartered Insolvency and Restructuring Professional and Business Valuator. He regularly comments on a variety of TV, radio, and other media outlets on topics surrounding bankruptcy and writes a column for the Huffington Post. Hoyes has been a Licensed Trustee since 1995 and testified before the Canadian Senate’s Banking, Trade, and Commerce Committee in 2008.