When you start a business, you have high hopes for the future and you’re optimistic about everything. You probably don’t want to think about what happens if the business doesn’t work out and you end up in masses of debt, but you should.
No matter how amazing your idea is and how well you run the business, there is always a chance that you can fail. If your business gets into a tough financial situation and the debts start piling up, how does that affect your personal finances? In some cases, you may be personally liable for the debts of the business and that can be devastating. You could end up losing your car or even your house to cover the losses of the business, so it’s vital that you protect yourself.
If your business is buried underneath large debts, here’s how you can protect your personal finances.
Separate Your Personal and Business Finances
If your business and personal finances are mixed together, it becomes incredibly difficult to separate them later on and when the debt repayments are due, you will end up footing the bill. That’s why it’s so important to separate your personal and business finances from the very beginning. Find out how to open a business bank account before you do anything else and make sure that you always keep your finances separate. This stops you from pouring personal money into an already failing business and putting yourself in a bad financial position. You should be very strict about keeping things separate because it’s a slippery slope once you start making personal purchases on your business account and vice versa.
As well as physically separating your finances, you need to legally separate yourself from the business. A sole proprietorship or partnership is easy to set up but the finances and assets of the business are not separated from your own personal finances in any way. If the business ceases to exist, all of those debts are passed on to you, which leaves you in a terrible position. If you file for bankruptcy, your own personal assets will be taken into account and for all intents and purposes, it’s the same as personally filing for bankruptcy.
It’s much safer to incorporate the business instead because this reduces your liability. The assets of the business are completely separate from your own, and so are the debts. If the business gets into hot water and you can’t afford to pay off debts, your personal assets won’t be at risk.
Never Personally Guarantee a Business Debt
If you personally guarantee a debt, you will be liable for it when the business fails, even if you incorporate the company. Most small business startup loans require a personal guarantee so there isn’t much you can do. However, if you borrow money in the future, it’s never a good idea to guarantee the debt, especially if you already have personal debts like student loans or credit card debts. Unfortunately, a lot of business owners make this mistake when they are going through a rough patch.
If you try to borrow money and nobody will lend money to the business unless you personally guarantee the loan, it is tempting to agree so you can keep the business alive. However, you should see this as a sign that things are already getting bad and risking your own personal finances at this stage is not sensible.
Sometimes, suppliers or landlords may ask you to personally guarantee payments. If they do, you should negotiate the contract with them and ask them to remove this requirement. In most cases, you will be able to come to an arrangement but if you can’t, you should think twice about working with them.
Be Careful Who You Make a Director
People often make friends or family members directors of their business, usually because they think that major shareholders must also be directors. This isn’t actually true and making people directors of the business makes them liable for certain debts, so it’s very risky.
If the business collapses and there are still debts owed to the government, anybody that is listed as a director is liable for that money. They also have a legal responsibility to pay any employees for wages or vacation pay that they are owed. If you make a friend or family member a director and they don’t understand this, they’re going to get a big shock if the business folds and they are suddenly liable for lots of your debts. This is going to cause a lot of tension and it will be you that has to foot the bill.
The situation is a little different if they understand the risks and they are actively involved in the business. In that case, they agree to take on the risks just as you have and they won’t expect you to pay out if the business fails. So, make sure you only name somebody as a director if they actually help you run the business and have money invested in it.
Consult a Lawyer Early On
The right legal advice can help you get out of some tough situations, but only if you consult a lawyer early on. Don’t wait until your business has collapsed and your debt repayments are way overdue because it could be too late by then.
When you are first setting up the business, get some advice from a business lawyer. They will help you set up the company in the right way so your personal assets have as much protection as possible. If things start to go wrong and it doesn’t look good for the business, you should get in touch with a lawyer again. Let them know that the debts are starting to pile up and you are concerned about the future of the business. They will make sure that you have as much protection as possible and help you safely get your personal assets out of the business.
Starting a business is always a risk but if you take this advice into account, you can stop business debts from destroying your personal finances.