If you’re unable to repay your business’s liabilities, whether those debts will affect your personal finances depends on how you’ve set up the business and whether you’ve acted in it and its creditors’ best interests.
Depending on your business’s circumstances, there may be several solutions that can help limit the impact of its debts.
The difference between limited companies and sole traders
How you set up your business will affect how its debts could impact you if they become unaffordable.
- Limited company
Incorporating your business in a limited company means you’ll benefit from limited liability protection. This separates the company’s debts from your personal finances and prevents any of the company’s debts from affecting you personally. - Sole trader
You and your business are one and the same if you operate as a sole trader, including your financial obligations.
Personal liability and limited liability protection
Even if you set up a limited company, there are still instances where you could be held personally liable for your business’s debts, such as:
- Personal Guarantees
You may have signed personal guarantees as security to a lender in exchange for business funding. If your company becomes insolvent and the guarantee is still outstanding, it will invalidate your company’s limited liability protection and make you personally liable for the amount. - Misuse of COVID support schemes
During the pandemic, the UK government launched several support schemes to help businesses cope with reduced trading and operating restrictions. If this support was obtained through dishonest applications or the company used the support outside of what it was intended for, you could be held personally liable for the misused amounts.
- Borrowing money from the company without repaying it
As director, you can borrow money from your company, though this means you will owe that money back to the company. While you owe that money, the director’s account will be ‘overdrawn’. If your company enters liquidation, then as director, you will be liable for that overdrawn amount. - Trading whilst insolvent
If you become aware that your company is insolvent and continue trading as if nothing is amiss, then you could be trading whilst insolvent. This puts you at the risk of wrongful trading, which could lead to you being held personally liable for the company’s debts, and even a ban from being a company director for up to 15 years.
How to resolve your business’s debts and limit personal liability
If your business is insolvent and you do nothing, you’re putting yourself at greater risk of incurring the consequences listed above.
To make sure you’re acting in the business’s and its creditors’ best interests, you should take advice from a licensed and regulated insolvency practitioner (IP) who can assess your situation and advise you on the best course of action and what to avoid.
While you can speak to your accountant for some general advice, they can’t carry out a formal insolvency process unless they have the appropriate qualifications.
Depending on the business’s circumstances, one of the following solutions may be possible:
- Formal repayment arrangements
If your company has a business model which would be viable if not for the burdensome debts, it might be possible to repay a portion of the debt at an affordable rate in monthly instalments. In which case, the IP may suggest your company enter a Company Voluntary Arrangement (CVA). This is a formal repayment arrangement which usually lasts around five years, with the company continuing to trade for the duration. Once the arrangement concludes, all remaining unsecured debt is written off.
A similar arrangement exists for sole traders: an Individual Voluntary Arrangement (IVA).
- Restructuring the company
If the company has deeper-rooted issues or creditor pressure is too intense, the IP may suggest that it enter administration. This is a temporary state wherein the company is protected from creditor pressure, and the IP will analyse the company’s financial situation, including its assets and its structure, and make the changes necessary to return it to a profitable state. Administration may be used where the company could be rescued as a going concern, or if it would achieve a better outcome for the creditors than if it were liquidated. - Voluntary closure
Sometimes, recovery might not be feasible, and the company would be better off closing through liquidation. Insolvent companies voluntarily close through a Creditors Voluntary Liquidation (CVL), which will draw a line under the company’s debts and end its legal existence. If you’ve fulfilled your directorial duties and acted within the company’s best interest, this leaves you free to walk away.
If you are a sole trader with no feasible way of repaying your business’s debts, then entering bankruptcy may be your best option. However, this can limit your ability to enter or practice certain professions, so you should check with your IP before applying.
Summary
How you’ve set up your business will have a bearing on what can happen if it becomes insolvent. Limited company directors benefit from limited liability protection, which mitigates the risk if they have acted in the company’s best interests. However, this protection can be bypassed depending on how the director has acted. If your business is insolvent, you should speak to a licensed and regulated insolvency practitioner (IP), who can advise you on your options and guide you towards the best solution for your business.
