Could bad business debts have an impact on your personal finances?

The short answer is yes, bad business debts can negatively impact the personal finances of business owners in some cases, but it depends on the structure of your business.

If you are a business owner and your business has accrued a high amount of debt, or you are considering starting a business, here are some points to consider if you have concerns about your business’ finances affecting your personal finances.

What is considered a debt in business?

Arguably, taking on debt is an inevitable part of growing a business.

When setting up or expanding, it’s often necessary to acquire premises, equipment, staff, materials, and to keep a healthy supply of cash flowing through the business for day-to-day operational costs.

In most cases business owners will achieve this by borrowing funds.

For example, they could do this via:

• Asset finance arrangement (purchasing or leasing equipment)
• Business loan
• Commercial mortgage
• Business credit cards.

The finance makes it possible to invest in the business so that it can increase profit without parting with large amounts of cash up front, protecting cash reserves.

Ideally (but not always) the additional revenue that the investment generates can more than cover the finance repayments, making it a cost-positive solution.

What is considered bad debt in business?

In general, debt is a useful tool for growing businesses but, sometimes, business debts can build up in an unmanageable way. This can then be made worse if business owners find themselves facing unexpected costs or losses, and down the line they may be unable to keep up with finance repayments.

While a few late or missed payments might not be an issue if you are in regular contact with your lender, continuing to miss payments can result in long-term damage to your business’ credit file.

Just as your personal credit score is affected by missed repayments on personal loans, mortgages or credit cards, when a business falls behind with their repayments, its credit score is negatively impacted. If you do fall behind, it’s important to tell the lender as soon as possible as they may be able to work with you to find a solution.

Business debt: who is responsible?

During the application process for business finance, at least one person will need to take responsibility for upholding the agreement, i.e., making sure repayments are made on time. Who this will be will depend on the structure of the business.

Sole traders and partnerships

In the case of sole traders, the business owner and the business are viewed as one and the same, so the owner is personally liable for any debt taken on even if it was for the business. Should the business fail, the owner will need to file for insolvency, e.g., bankruptcy or an IVA.

A partnership is much like the sole trader entity, only all partners are personally responsible for the business’ debts.

For sole traders and partners, defaults, late payments or ‘blackmarks’ against your business’ name will damage your personal finances.

Limited Companies

For limited companies, debts are borrowed against the name of the company so the owners are not responsible for repaying it and their personal credit score would not be impacted. Limited companies that cannot repay their debts may need to file for administration which can lead to liquidation of the business’ assets to release funds that can be paid to creditors.

However, where Personal Guarantees are involved, the situation for owners of Limited Companies can become more complex.

What about Personal Guarantees (PGs)?

Business owners will sometimes use a Personal Guarantee to secure finance which is a promise to repay credit issued to a business (usually a director or partner of the business). It is typically signed during the finance application process and is a legally binding contract.

If the business becomes unable to repay the debt at any point, then the individual who has signed the personal guarantee may become personally responsible for the debt, even in the case of Limited Companies. This means the lender may call on the personal guarantee to cover any outstanding debts and will go after the guarantor’s personal assets, e.g., your home, your savings, investments, and other valuable assets. The personal guarantee is therefore seen as “added security” for lenders.

It is possible, however, to include Personal Guarantee Insurance to a finance agreement, to reduce the risk to your personal finances.

For more information, visit our blog on Personal Guarantees and Personal Guarantee Insurance.

Concerned about cashflow or excessive business debts?

If you have concerns about your business’ cash position or level of debt, it’s important to seek independent advice as soon as possible, as there may be steps you can take to boost cashflow or reduce your exposure.  

• Debt consolidation or cashflow loans
• Loans to spread the cost of tax bills over time
• Invoice finance to unlock cash held in unpaid customer invoices
• Asset refinancing to release cash from assets you already own.

To discuss how any of the above in more detail, contact our experienced and friendly team of finance professionals using the form below.

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