The Small Firm, the Draw, and Money That Is Not the Firm's

A partner in a small firm is not paid a salary. He takes a draw, which is an advance against a share of a year that has not finished.

The firm also holds an account containing money that belongs to other people and may never be treated as the firm's.

Both facts are ordinary, both are understood by everybody in the building, and together they describe a liquidity position that looks nothing like an employed professional's. That is the subject of this page, and it is not a question about a product.

What arrives every month, and what it actually is

An estimate. The firm projects what the partnership will earn, allocates it according to the partnership agreement, and pays instalments against that projection.

The projection is made before the year is known. Collections, write-offs, a matter that settles early and a client who does not pay all move the final number, and none of them is visible in January.

So the amount arriving monthly is provisional in a way a salary is not. It can be revised upward when the accounts are settled, and it can be revised the other way.

Which matters because household obligations are not provisional. A mortgage payment, a school fee and an instalment on a purchase were all set against the draw, and they do not adjust when the draw does.

The true-up, and the year it goes the other way

At year end the estimate meets the accounts. Where the firm earned more than projected a further distribution follows. Where it earned less, the excess already taken has to be recovered.

Recovery usually means reduced distributions for a period, and under some agreements a direct repayment within a set time. The partnership agreement governs, and it is the document to read rather than the practice to assume.

The timing is the part worth naming. The correction arrives with its own cause: the year that produced less is the year a significant client left or an account went unpaid, so the shortfall and the reason for the shortfall land together.

And tax does not follow the draw. A partner is generally taxed on the share of partnership income allocated to him rather than on what he withdrew, and instalments are his personal obligation. How that operates for any particular partner is a question for the firm's accountant, who is the person who computes it.

The account that holds money the firm does not own

Funds held in trust belong to the clients on whose behalf they are held. They may be applied only as the retainer and the applicable law society rules permit, they are accounted for separately, and they are not available to meet the firm's obligations.

Those rules are provincial and differ in their detail. The rules that govern a particular firm are the ones that govern it, and no general description substitutes for them.

The result is a balance sheet whose largest number is often not the firm's money. Every practising lawyer knows this. Almost nobody outside the profession does, which is why advice built for business owners frequently misreads a law firm's position at first sight.

And the discipline it produces runs deeper than the accounting. A profession trained to keep other people's money strictly separate tends to be careful about money generally, which is an advantage when the question is what the firm's own capital is doing.

What that does to how a small firm holds liquidity

The firm's own liquidity is a short list. The operating account, work in progress that is billed and collectible, and whatever reserve the partners have built. Trust funds are not on it.

In a firm of two or three partners that list is small and moves quickly. A handful of matters drives it, one late payment from one client is material, and the partners are the people who absorb the difference.

The usual answer is an operating facility, which is sensible, is secured or guaranteed personally more often than not, and is priced by somebody who reads the same financial statements the partners do.

None of that is an argument for a product. It is an argument for knowing the number, written down, in a form a partner can read in ten minutes. Most small firms have never produced it, and it costs nothing.

What the practice is worth, and to whom

Less than the partners usually assume, because much of what produces the revenue is attached to individuals rather than to the firm.

A client relationship cannot be conveyed. It can be introduced, and the client decides. Files move on the client's instructions, not on the terms of a sale agreement.

What does transfer is narrower than it looks. Precedents, systems, staff, a lease and a name have value, and in most small practices that value is modest beside what the partners have earned from the work.

Firms with institutional clients and recurring instructions are the exception, and they sell because the work does not depend on one name. Which of those two descriptions fits a particular firm is answerable now rather than at the end, and the answer changes what has to be built in the meantime.

Where the personal exposure sits

In two places, and they are commonly confused. One is the professional obligation attaching to the individual who does the work. The other is the commercial obligation the partners have signed.

The first is set out elsewhere on this site. How a claim can arrive years after the work, and what it means for a practitioner who is the licence, is dealt with for a design practice and its liability tail and the mechanism is the same one lawyers live with. It is not repeated here.

The second is the lease and the credit facility. A landlord dealing with a firm of three commonly requires personal covenants, and a lender advancing an operating line commonly requires guarantees. Those obligations outlast a poor year.

Whether they outlast a partner's death, and on what terms, is answered by the documents. Reading them, listing what is owed and setting the list beside what the firm and the partners could actually produce is a short exercise, and it is the one that tells a partner whether anything needs funding at all.

The partner who leaves, and what goes with him

In a small firm a departure is also a transfer of revenue. The clients who came for that partner will usually follow him, so the firm loses both an earner and part of the base against which the remaining partners draw.

The agreement will say what is paid for his interest. It will less often say where the money comes from, and the obligation to fund a departure is a funding question wearing legal clothing.

That question is argued in full for somebody arriving rather than leaving. A buyer's position, the terms he has no leverage to negotiate, and the clause about departure signed in the same week as the purchase are set out under buying into a partnership.

The point here is narrower. A firm small enough that one departure moves the revenue materially is a firm whose reserve has to be its own rather than the market's, because the year it is needed is the year borrowing is hardest.

Infinite Financial Sovereignty®, and whose idea the underlying one was

The underlying idea is not this practice's. The method Nelson Nash named The Infinite Banking Concept® is a mark of Infinite Banking Concepts, LLC, described in his own writing, and neither Canadian Wealth Creation Centre Inc. nor Jose Salloum is affiliated with that organisation or endorsed by it.

Infinite Financial Sovereignty® is this practice's own registered mark, and it names one narrower discipline held to over a lifetime: that a person or a business should be its own source of capital for the requirements it meets repeatedly.

In practice it means holding capital inside a participating whole life contract issued by a federally regulated insurer. The contract accumulates a contractual value, and when capital is needed an advance is requested against it rather than arranged outside, then repaid on a schedule the owner sets.

None of that is free, fast, or a way of escaping interest. The insurer charges interest on an advance, the costs fall heaviest in the early years, and what changes is the destination of the financing margin rather than its existence.

What capital under the firm's own control changes

It changes which shortfalls have to be taken outside, and nothing else. A draw corrected downward, a quarter in which collections are late, a lease deposit on new premises: those are the ordinary uses.

It does not change the terms of an operating facility already in place, and a firm should keep one. Committed external credit built in a calm year is worth having in a difficult one.

The repayment discipline is the strategy. Capital drawn from a contract and not repaid has been spent rather than borrowed from a different source, and a partner who will not hold to a schedule he set himself should not begin.

The death benefit is doing its own work throughout. This is life insurance, and for a partner carrying personal covenants on a lease and a facility, what it pays on death is not a secondary consideration.

Who owns the contract, and why it is decided first

Ownership is the decision everything else follows from. Whether the owner is the partner, a professional corporation or the partnership itself changes the tax treatment, the balance sheet and what happens on a departure.

Three things are decided together: who owns the contract, who pays the premium, and who is named as beneficiary. Letting them be settled by whoever completes the application is the commonest expensive error in this area. Where one party pays a premium and another is advantaged by it, a taxable benefit can arise for whoever was advantaged, and that is typically found later on an audit.

Where a contract is meant to answer an obligation in the partnership agreement, the two documents have to say the same thing. The structuring of corporate ownership is set out under corporate-owned life insurance.

What a law society permits a professional corporation to do, and who may hold its shares, differs by province. That is a question for a lawyer advising on the structure where the firm practises, which in this instance is a reader capable of finding the rule himself.

What the tax treatment depends on, and who decides it

On facts about the firm and the partner, confirmed with the firm's own accountant before anything is applied for. That is the load-bearing condition of everything above it rather than a disclaimer beneath it.

Premiums are generally not deductible. A narrow exception can apply where a policy is assigned as collateral for a loan used to earn income, subject to conditions that must be met rather than assumed.

Growth inside the contract is not taxed annually while the contract remains exempt under Regulation 306, Income Tax Regulations. Exempt status is maintained rather than inherent, and a contract altered carelessly later can lose it.

An advance against a contract is a disposition for tax purposes under ITA s.148(9), and amounts above the adjusted cost basis can be taxable, particularly where a contract lapses or is surrendered while an advance is outstanding. The mechanics are under policy loans.

On death, the amount by which the benefit exceeds the adjusted cost basis is credited to the Capital Dividend Account of a corporate owner under ITA s.89(1). The credit is the excess rather than the whole benefit. The firm's accountant calculates this. Nobody else should.

What this does not do

It does not make a draw predictable. The estimate is still an estimate and the true-up still happens.

It does not eliminate interest. The insurer charges interest on an advance, and a presentation leaving that out has misdescribed the arrangement rather than simplified it.

It does not reduce a partner's tax bill, and nothing here is a deduction.

It does not outperform a market portfolio measured as a return. Participating whole life insurance is an insurance product and not an investment, a difference in purpose rather than in marketing, and a partner shopping on rate of return will be disappointed by an honest comparison.

And it does not survive being started and abandoned. A contract surrendered early returns less than was paid into it, permanently.

Who this does not suit

A firm without durable surplus in a normal year, as distinct from a strong one. That describes many small practices, and it is a sufficient answer on its own.

Partners within about a decade of winding down. The early costs will not have been recovered and the compounding has no time to work.

A firm carrying expensive debt, where repayment is usually the better use of the same dollar.

Anybody who may need the capital back within a few years, because early exit is a permanent loss rather than a delay.

Partners who want to be compared on rate of return, who will find the comparison unflattering and should.

And any firm whose accountant has not seen the structure, because a structure nobody has checked is the one that surfaces on an audit.

What stands behind the contract

The contractual obligations of the issuing insurer, and nothing else. They depend on that insurer's continued solvency and are not backed by any government, which is a materially different position from a deposit at a chartered bank.

Assuris protects Canadian policyholders within its published limits where an insurer fails. That is meaningful, it is not deposit protection, and the difference is worth establishing before rather than after.

Dividends are not guaranteed. They are declared annually at the discretion of the insurer's board based on the performance of the participating account, and past dividend performance does not indicate future results. The guaranteed schedule in a contract and the projected values above it are two different columns on one page and should be read separately.

Questions worth putting to whoever proposes this

What the contract returns on surrender in year three, in figures. Not the principle, the number, and beside it the total of premiums paid by that point.

Which column is contractual and which is projected, and what the projected column does if the dividend scale falls. Any illustration that does not separate the two has been presented rather than explained.

What is assumed about premium payments in every year, and what breaks if a year is missed. That assumption is where most of these arrangements fail.

What the proposer is paid on the recommendation, and what he would be paid if the firm simply built a reserve instead. The reaction is informative whatever the answer.

And whether an accountant who has implemented one before has reviewed the structure. Not one who could, one who has. Every answer above is checkable, which is the only reason the questions are worth the time.

Who you are dealing with

IBC Financial is the education platform and trade name of Canadian Wealth Creation Centre Inc. Every client relationship, every piece of advice and every insurance product comes through Canadian Wealth Creation Centre Inc. and its duly certified representatives, and this page is education rather than advice about any particular firm.

Everything here is written by somebody paid a commission by an insurer when a contract is issued, which is stated at the foot of every page on this site and is a reason to check the arithmetic rather than to accept it.

The corporate structuring underneath all of it is in business owners, the mechanism of the contract itself is in how a participating policy works, and the succession question a firm eventually reaches is set out under the succession planning process.