While being in business has its ups and downs, it’s natural to have concerns about the burden it may bring to your personal life, including your finances. We’ve heard stories about people losing money or falling into financial disrepute following an entrepreneurial venture. The reality is that these instances are rare and can be avoided in many cases.
If you are launching a business, you need to be confident that it is going to succeed. This will give you the motivation to undertake the financial risk and move forward. With a great idea and an effective strategy, your business should go from strength to strength, bringing you profit as a result.
You may need to take on debt to fill a funding gap or reach your goals. Plenty of businesses do this and, when used correctly, it should not have a detrimental effect on you or your company.
This being said, you must seek to protect any downside. This means understanding the connection between business debt and your personal finance and taking the proper steps to minimise any risk.
This guide explains how business debt can impact your personal finance and what you can do to minimise it from happening.
- Does business debt always have to be connected to your personal finance?
- How to stop business debt affecting your finance
Does business debt always have to be connected to your personal finance?
In the early stages of a business, when you are trying to get off the ground to start generating revenue or before approaching external financers, it’s common for entrepreneurs to invest their own money. This will typically cover start-up costs, securing supplies and equipment or covering other administrative costs required to launch a business.
This is particularly the case for those starting as sole traders who are personally liable for their business venture.
In due course, the business will hopefully start to become profitable and you can start to recoup your initial outlays.
If you run into financial issues later down the line, it may be tempting to use your own funds to bridge the gap and ‘solve’ a problem. While it’s understandable for many business owners to take this step, it can quickly spiral, especially if your business does not recover. This can ultimately leave both you and your business in debt.
There are also other times when your personal finance and business may be tied together, such as acting as a personal guarantor for a commercial loan.
While entrepreneurs should not have to use their own money for their business, it frequently happens. That’s why it’s essential to take protective measures to minimise any danger for both you and your business.
How to stop business debt affecting your finance
You can take a few precautions to best protect yourself against any business debt you may incur. We’ve listed the sensible steps to take below.
Have a viable business plan
Every entrepreneur should aim to have a profitable business, enabling it to run financially independently from its founders (and pay you a suitable living!). First and foremost, this means your revenue needs to exceed your costs. By keeping to this simple rule, you should reduce the need to draw upon your own funds.
To reach this nirvana, you need an effective long-term plan that enables you to grow your sales and optimise your operations which ensures your success. This includes having a sensible growth strategy that allows you to expand sustainably and with access to the finance you need.
By carefully planning and ensuring your business operates efficiently, you can deliver financial stability and prevent the need for you to intervene or mix business debt into your personal life.
Maintain financial stability
If there is any cashflow issues in your business, you may choose to plug the gap with personal finances and prevent the problem from deteriorating. However, this is a slippery slope that you really don’t want to go down as it could lead to you constantly dipping into your pockets to solve every issue.
A better long-term fix is to aim to maintain and improve financial stability as much as possible. By optimising your finances internally, you will strengthen your resilience and enable your company to operate independently.
Examples of improving financial stability could include:
- Implementing appropriate credit management processes that encourage people to pay you on time and react when they do not – thereby preventing funding gaps
- Building financial reserves to utilise in times of trouble
- Considering cutting costs or removing unnecessary expenses to maintain good cash flow
- Understanding the external funding you can use to ease specific situations, and ensure they fit into your affordability criteria
By staying on top of your finances internally, you can limit the extent of any cash problems while acting swiftly to find a resolution that does not require you to delve into your personal bank accounts.
Choose the right business structure
As we have already touched upon, sole traders or partnerships, by definition, are personally liable and have unlimited liability. Being a sole trader or partner may put increased pressure on them to succeed and make it more challenging to separate their business finances from their personal lives.
If this risk is too high, there are other types of business structures that offer more protection. This includes limited liability partnerships, where the responsibility is limited and shared with other founders, or limited companies, which sets the business as a separate legal entity, thereby protecting its owners.
By understanding the implications of the various business structures, you can select the one that works for your needs. It’s also worth noting it’s possible to change the structure as your business evolves, such as moving from sole trader to limited company.
Utilise support
When a funding issue arises in your business, rather than your first port of call being your pocket, you must consider the use of external support.
While it may seem counter-intuitive to secure a loan to bridge a funding gap, there are now plenty of options on the market designed to help businesses access solutions for whatever issue they may face. This includes short-term loans that aim to boost cash flow and give companies a chance to get back on track.
If you aren’t sure about what funding you need or the support that exists, it’s worthwhile contacting a commercial finance expert who can take you through everything and pinpoint options that address your current needs.
Remember before committing to a loan that you can afford the repayments, so you can avoid falling into any further debt.
Remember to pay your salary
Often when running a business, amidst the many priorities you have, paying yourself a wage comes last. While it’s understandable how this happens, it often places an unfair strain on you, the owner, and impact your personal finances.
It is key that you build a salary into your business finances just like you would other monthly expenses. This will enable you to consistently get paid for your hard work while avoiding letting your business detrimentally impact your personal wealth.
Use personal guarantee insurance
Many lenders will ask for security against a loan to mitigate the risk of your business defaulting on payments. Typically, this security comes in two forms: assets, which can be repossessed to clear the balance, or a personal guarantee.
With a personal guarantee, an individual agrees that they will repay the balance if your business cannot. It’s not uncommon for a business owner or director to act as the guarantor.
While using a personal guarantee can be helpful for companies to secure the loans they need, it’s often agreed with the thought that the business will meet repayments. If you are suddenly called upon as a guarantor, it can be stressful and require you to personally repay any outstanding balances.
Due to this risk, it is recommended to take out personal guarantee insurance (PGI). PGI serves to protect you against the risk of having to repay your business’s loan in exchange for an annual premium.
If the loan is unsecured then cover starts from 60% in year one, increasing to 70% in year two and 80% in year three onwards. For secured loans, cover is 80%. This will reduce a significant part of the cost owed by you, helping you to maintain your personal finances and avoid potential ruin.
Speak to someone if you are struggling
If your business is facing financial hardship and impacting your personal life, it may be time to speak to someone.
By reaching out to an expert, such as a restructuring and turnaround advisor or insolvency practitioner, they will be able to identify suitable options forward for you, including operational changes and funding options that can get you back on track or even your insolvency and bankruptcy options. A proactive strategy will may help to minimise the impact on your personal finances.
Conclusion
It’s common for your business to feel like a dominant part of your life – but that doesn’t mean you should constantly be looking to fund it through your own money. By doing this, you may be weakening the financial stability of your company while harming your life outside of the business.
Fortunately, there are solutions that can enable entrepreneurs to fund their businesses and solve cash issues without resorting to their personal savings. You can also take measures to protect yourself and reduce your risk, such as personal guarantee insurance.
To explore any of the options we have highlighted, please get in touch with us.