Putting Personal Money Into A Limited Company: What You Should Know
When cash flow problems arise, some directors see putting personal money into a limited company as a simple solution to tide things over.
In some cases, you may find that’s the easiest solution and the business can pay you back once the cash flow issue is resolved.
However, if the business continues to struggle financially, you may never get your money back.
Here is what you should know when thinking about putting personal money into a limited company.
Why does the business need your own money?
The first thing to work out when contemplating putting personal money into a limited company is why you need to do this.
For example, perhaps the business has a relatively minor and short-term cash flow issue, due to the late payment of one of its invoices, but you’re certain it will be paid soon.
In this scenario, you might feel confident about putting personal money into a limited company, to resolve the cash flow shortage temporarily as a one-off.
However, what if the business regularly faces cash flow problems? What if there’s a considerable decline in sales, or an increase in unpaid invoices, or high expenses?
When a business is clearly unable to pay bills or taxes on time, it’s failing the cash flow test, one of the main signs it could be insolvent.
In situations like this, using personal money in a business is very risky, in case it ultimately goes insolvent – more on this later.
Putting personal money into a limited company
Naturally, it’s usually quicker to put personal money in a business than get outside funding from other sources.
Raising capital or securing a loan can sometimes be a very lengthy and time-consuming process.
Putting personal money into a limited company can also be a cheaper way to borrow funds, in comparison with interest rates on bank loans.
Director’s loan accounts are the official and safest way to make use of personal money in a business.
Director’s loan accounts
When employees do lend their own money, this should be recorded as credit to their director’s loan accounts.
In contrast, funds taken from limited companies that are not salaries, dividends or expense repayments should be accounted for as debits to their director’s loan accounts.
At the end of the financial year, the total owed by them or the company to each other should be included on the balance sheet.
If you or other employees do set up director’s loan accounts, bear in mind that you or the company may have to pay tax, depending on whether the accounts are in credit or overdrawn.
Regulations for director’s loan accounts are stipulated in the Companies Act 2006.
What happens if the business enters liquidation?
Leveraging personal money in a business may seem like a reasonable next step, when banks won’t lend money due to failed credit checks.
However, if that’s the case, it’s worth thinking about why these applications were rejected.
If banks don’t have faith in the business’ long-term prospects, it’s a warning that your own money may not be a wise investment in the company either.
When businesses do enter liquidation, by putting personal money into a limited company, if director’s loan accounts are in credit, then the directors count as creditors.
Be aware though, that they are classed as unsecured creditors.
The payout hierarchy when a business enters liquidation is to secured and preferential creditors first and foremost, before unsecured ones, including customers and suppliers.
When a company is insolvent and goes into liquidation, there’s often very little money left to share and it’s not guaranteed there will be anything left for unsecured creditors.
Summary: putting personal money into a limited company
Using personal money in a business could be a quick and cost-effective way to resolve short-term cash flow problems, in some scenarios.
Putting personal money into a limited company is nevertheless a risk, particularly if the cash flow problems are due to insolvency.
Director’s loan accounts are a good way to record transactions when you’re putting personal money into a limited company, they also class you as an unsecured creditor.
However, this does not guarantee your money back if the business enters liquidation.
When a limited company has cash flow problems, other forms of financing may be safer, including debt financing. In which case, seek advice from experts in company debt solutions.For more guidance about debt solutions, or putting personal money into a limited company, or director’s loan accounts, please contact us for a no-obligation discussion.
