Running a business is hard work. You often spend most of your hours working in or thinking about the company.
However, it is important to keep your personal life and business as separate as possible when it comes to financing. The only exception may be the early days, where you utilise your savings to get your enterprise off the ground and kickstart operations.
The reason for doing so is that if your business ends up in debt, you don’t want to be left responsible. It could put a sizeable drain on your private finances and create wider ramifications for your life and family.
If you’re wondering whether you are liable for business debt, we have explored the instances where you might be and what you can do to protect yourself.
When you are liable
There are many instances where you may be liable for your business’ debt. We’ve listed them below – though it is important to note every situation is unique, and you should spend time researching your specific circumstances to be sure.
If you have signed a personal guarantee
When securing a loan for your business, there may be instances where a lender asks for a personal guarantee. This is where someone – often the company director – agrees to cover the balance if the business defaults on payment. Typically, it is used to offset the risk to the lender and increase your eligibility for funding.
If the business fails to meet this requirement, you will be called upon to pay the shortfall using your personal assets.
If you have received CBILS or BBLS funding
Throughout the coronavirus pandemic, many companies utilised loans via the Coronavirus Business Interruption or Bounce Back loan schemes.
Following the misuse of these schemes, the government announced laws designed to prevent fraud. Under the rules, current and past company directors may be investigated. The Insolvency Service may also remove any protection offered to a limited company so that directors are liable for any debt.
Once again, if you stay on top of your payments, this should not become an issue.
If you trade wrongfully
Another situation in which you could become liable for your business debt if you trade wrongfully.
An example of this is after you declare insolvency. In this instance, the priority goes to creditors rather than your shareholders, meaning you need to focus on repaying debt rather than generating revenue. If you are found to continue to operate for gain, it could leave you liable for the outstanding debt.
Similarly, if you take out a loan using fraudulent claims or false information, you will be expected to repay the debt.
If you use your home as loan security
Some lenders will require security to accept you for funding as an alternative to a personal guarantee. The security again offsets the risk, giving them a way to clear the owed debt if you do not keep up with the agreed payment schedule.
In many cases, you will use business assets as loan collateral. However, there may be circumstances where you may need to use your home as security as well as or instead of other security.
If repayments default, the lender has the right to repossess your home.
If you borrow money from your business
Some directors may utilise a director’s loan account (DLA) to record transactions between directors and the business. If you take more money out than is owed to you, the account will become overdrawn.
Some companies write off DLAs in their end of year accounting as it offsets their dividends paid out. However, the loan doesn’t go away – as with any loan, they are subject to interest and tax, meaning the amount you owe will increase.
The only way to prevent it from increasing is to clear the balance by putting in the money you have withdrawn or paying yourself dividends.
Our tips for protecting yourself against debt
Now that you know the circumstances under which you may be liable for your business debt, you must do everything you can to mitigate the risk and protect yourself. We list our top tips for doing so below.
Get personal guarantee insurance
If you use a personal guarantee for a loan, it is crucial that you also take out personal guarantee insurance (PGI). PGI covers you between 60-80% of the total loan amount, meaning that if the worst happens and you are required to honour your personal guarantee, you do not need to front all the cash.
This can lift a substantial weight from your finances – and give you peace of mind.
Avoid using personal loans or credit cards to finance your business
Another instance in which you will be liable for business debt is when you use personal loans or credit cards taken out in your name rather than the company’s.
As the loan is technically yours, you will be left repaying any debt even if the funds are used for business purposes. That means it’s best to avoid financing your business in this way and focus on getting commercial loans instead.
Always be honest in funding applications
Fraudulent claims will leave you liable for the debt once the lender withdraws funding. It will also damage your reputation and make it much harder to secure external finance in the future.
As such, always be truthful when filling out a loan application. This will ensure that any funding is rightfully given, with no risk of it being taken away. It also means you’ll be able to obtain finance that accurately suits your needs.
Avoid taking money out of your business
Another way to avoid debt, specifically relating to DLAs, is to stop borrowing money from your business altogether.
If you take money out, aim to promptly pay it back to avoid mounting interest and tax, unless it is in lieu of dividends.
Stay on top of repayments
In most instances where you become liable for debt, it’s because your business has defaulted on payments.
Therefore, the best protection against debt is staying on top of your repayments so it does not reach a point where you may be liable.
Maintain financial stability
In your bid to stay on top of debt, you also need to promote financial stability. Alongside maintaining healthy cost and profit balances, conducting regular audits of your financial accounts helps you uncover risks ahead of time.
Once you uncover issues, you will then take appropriate steps to rectify the situation before it evolves – ideally, without involving your personal finances.
Seek advice if you’re worried
If you are concerned about debt liability and your ability to repay owed monies, it is best to speak to a professional to get advice rather than let your concerns stew.
By speaking to a dedicated financial advisor, you will be able to determine if you are liable based on your unique criteria. They will also support you in maintaining financial stability across your business to minimise the risk of debt.
You will then take the appropriate steps to protect yourself personally while strengthening your business.
Conclusion
Understanding when you are liable for business debt is essential if you want to prepare yourself and get the support you need to overcome any unexpected bills.
Most crucially, it enables you to uncover the personal risk involved when securing funding – especially when using a personal guarantee, loans or other agreements that may result in liability. You will then make an informed decision that reduces that danger and focuses on separating your business finances.
If you are concerned about debt in your business and want to protect yourself, contact us to find out more about personal guarantee insurance, refinancing and other debt recovery solutions.