When cashflow is tight in your business it will often need fast funding to survive. One quick and seemingly easy option may be to use personal wealth to loan the business money. Avoiding bank rejections, mountains of paperwork and high interest loans is attractive. But putting your life’s savings on the line should not be done lightly.
Before you loan your business money seek expert advice to avoid losing your personal wealth.
We see many clients who have exhausted bank funding and borrowed against their home to help their business. But if the business then fails, their personal money is also lost. Risking your personal assets to keep your business alive, and deciding where and how you will loan the business money, need to be considered before taking the leap.
Before putting personal money into your company
Before injecting any money into your business, you should first be clear on the following:
- That your company’s business is viable, operating profitably and efficiently.
- You have an intended purpose or plan for the money, to make the most of it.
Putting money into a business that’s losing money or running inefficiently can be like pouring water into a leaky bucket. Injecting personal, or any other funds, into a business to meet expenses, or just pay off debts may merely be a Band-Aid solution. If your company is struggling or potentially insolvent, it may need a comprehensive turnaround plan.
You certainly don’t want to be in the same position in three to six months, having also expended your available personal funds and increasing your risk of personal bankruptcy. So speak to your accountant or a turnaround advisor to help here.
Protect the money you loan to your company
If you decide to loan your company money make sure you have a plan in place. The below options improve your chances of being repaid in the event your company does go into liquidation at a later stage:
- Repay a loan
- Take a security interest over your company’s assets
- Stand in the shoes of the bank or financier you’re paying out
- Assess the solvency of your company at that time
- Use the funds to pay employee entitlements
Looking at these in closer detail:
1. Repay a loan
Many directors withdraw their wages as drawings instead of as an employee. Accountants like this method as it saves tax, but it creates a loan owed by the director on the company’s balance sheet. A liquidator would demand repayment from the directors for this loan balance.
If you have a loan account, any money you put into your company should be used to reduce the amount you owe the company. It is often the case that money loaned to a struggling company from relatives or friends is recorded as such in the company’s accounts. The problem this can create is that loans owed to, and by, different people cannot be offset when a company is insolvent or in liquidation. Like other assets, a liquidator is required to recover loan account balances to distribute equally to all creditors.
Accordingly, speak to your accountant about how best to account for the loan. It may be made directly to the company by the lender. Or you may instead borrow the money personally, and then loan it to your company.
2. Take a security interest over your company’s assets
Generally, if a bank loans you money the company will sign a General Security Agreement. This means that the bank will have security over your company’s assets. This is then registered on the PPSR (Personal Property Securities Register), and this security interest gives the bank priority for payment from the company’s assets ahead of other creditors.
You should do the same if you are loaning the money personally. Your lawyer can prepare a General Security Agreement for you to enter into with your company, and then register it on the PPSR. This needs to happen at the same time as loaning your company money, otherwise, it may be ineffective.
3. Stand in the shoes of the bank or financier you’re paying out
Following the above point, you may use personal funds to pay out a bank or financier that holds a PPSR-registered security interest over your company. In this case, request that the PPSR registration not be released to allow you to be subrogated to the bank’s security.
This means that you then take over the bank’s debt and security interest as if you had loaned the money to the company in the first instance.
4. Assess the solvency of your company at that time
If there is a concern about the solvency of your company, there is a risk that a subsequently appointed liquidator may later pursue an insolvent trading claim against you for debts incurred from that point forward.
Directors often raise a defence to insolvent trading that they intended to continue funding their company and it, therefore, wasn’t insolvent. However, often a company’s position worsens prior to liquidation and the defence fails.
Safe harbour protection is the best way to protect yourself from insolvent trading. However, documenting your company’s expected financial solvency position following the receipt of funding helps too. This will give you a better chance of relying on this defence if subsequently required.
5. Use the funds to pay employee entitlements
Employee entitlements and superannuation have priority for payment ahead of other creditors in a liquidation. This includes secured creditors with respect to assets subject to a ‘circulating security interest’ – cash, debtors and stock.
The Corporations Act provides that an advance to a company to pay employee entitlements, has the same priority for payment as the entitlements paid would have had in liquidation.
To retain the priority the company must pay the funds advanced:
- directly to employees and/or
- for superannuation, to the super funds or ATO.
Tom’s Case Study
Tom’s company was struggling. After making some changes to improve profitability, it became clear he had cash flow issues from debts he couldn’t pay. Tom’s bank had a PPSR security interest over his company for its $50,000 loan, and it wouldn’t lend him more money. He has a $70,000 superannuation debt and some overdue supplier debts holding up work.
Tom refinanced his house to access $100,000, and loaned this to his company, paying $70,000 to the ATO for superannuation guarantee charge. The remaining $30,000 paid down his supplier debts. The company subsequently lost a major customer and became insolvent so Tom put his company in liquidation to avoid further losses.
His company now had $10,000 cash, $50,000 owed by debtors and $40,000 worth of equipment. The bank had security over all the assets. However, because Tom advanced funds to pay the company’s $70,000 superannuation debt, in liquidation he was entitled to receive the $60,000 cash and debtors as repayment, while the bank received the $40,000 for equipment sold.
Tom ended up with $60,000 instead of nothing.
Before you loan personal money to your business, you should speak to the experts at Revive Financial. We can advise you of alternatives, potential dangers and help make the best use of your money.