The Ultimate Debt Management Guide for Limited Companies
The idea that all debt is bad could not be further from the truth. Debt can be a very useful tool when starting a business and fuelling growth at different stages of its development.
But sometimes, financial events outside of your control can take you further into the red than you planned. In that situation, debt can quickly become a problem that causes stress-fuelled days, sleepless nights, and potentially, even the failure of your business.
In this guide, we’re going to provide you with all the information you need to manage limited company debts more effectively. We’ve split the guide into four sections, each of which is designed to lead you through a key aspect of debt management for limited companies.
- How does the structure of a limited company protect you from debt?
- What are the common types of limited company debt?
- What steps can you take to manage limited company debt more effectively?
- What if you have limited company debts you cannot repay?
Part 1: How Does the Structure of a Limited Company Protect You from Debt?
Before we start discussing how to manage limited company debts, it’s important to understand exactly how debt can affect your business and the impact it can have on you personally as a company director.
The good news, and this is crucial to your understanding of limited company debt, is that the structure of your business is specifically designed to create a legal separation between the company’s finances and your personal finances.
If you operate as a sole trader, there is no distinction between your personal and company’s finances. If the business runs into financial difficulties and fails, your creditors (the parties you owe money to) will be able to pursue you personally for the debts of the business. You could be forced to repay debts using personal savings, sell personal assets such as your home and even file for bankruptcy.
As a limited company, you have ‘limited liability’ for the business’s debts. That means, if the company cannot afford to pay its debts and a creditor takes court action, only the finances and assets of the company will be at risk. The only money you stand to lose personally is your original investment in the company.
When can directors be made personally liable for company debts?
Despite the protection directors receive from their limited company status, there are still some instances when they could be made personally liable for the debts of the business. That includes:
- You sign a personal guarantee – This an agreement that states that if the company is unable to repay the debt, you will do so personally. Banks and finance companies are two examples of creditors that may ask you to sign a personal guarantee.
- You have unpaid PAYE and National Insurance contributions – HMRC is very persistent in its chasing of unpaid tax liabilities. It will pursue you personally if the company has PAYE and National Insurance contributions that have not been paid.
- Debts have accumulated due to fraudulent means – If a debt is created by an act of fraud, such as taking credit that you knew you’d be unable to repay, you could be pursued for the debt personally.
- Debts have accumulated after the company became insolvent – If you accumulate debts when you know the company is insolvent and there’s no reasonable chance of avoiding liquidation, you may be made personally liable for those debts.
- You continue to pay shareholder dividends when the company is insolvent – If you pay company money to company shareholders and directors rather than repaying your creditors, you could be liable for those debts.
- You use company funds for a non-business activity – This is known as misfeasance and it could leave you liable for the debts of the company.
- You dispose of company assets for less than their true value – The assets of an insolvent company are sold during liquidation to repay your creditors. Moving assets out of the business before they can benefit the creditors could make you personally liable.
- You have an overdrawn director’s loan account – An overdrawn director’s loan account is created when you take more money out of the company than you put in. If you do not repay the loan and the company fails, you could be personally liable for the debt.
What are the consequences of personal liability?
If you are made personally liable for a company debt, it will become just like any other personal debt and creditors will be able to take action against you to enforce it.
If you cannot repay the debt from personal savings or the sale of assets, you will have to explore the various personal debt solutions available. Depending on the scale of the debt and the value of your assets, your options could include a Debt Management Plan (DMP) or more formal insolvency procedures such as an Individual Voluntary Arrangement (IVA) or bankruptcy.
When can a limited company’s debts be written off?
If your company has debts it cannot afford to repay and you have not been involved in any activities that could give rise to personal liability issues, the company’s debts will be written off when you enter a formal insolvency procedure.
Procedures such as a Company Voluntary Arrangement (CVA), administration and a Creditors’ Voluntary Liquidation (CVL) are intended to provide the best possible return for the company’s creditors. Once those procedures are initiated, any outstanding creditors will not be permitted to take legal action against the company or demand payments from its directors personally.
Part 2: What are the Common Types of Limited Company Debt?
No business wants to be in a position where it has debts it cannot afford to repay. However, limited company directors must understand that some debts are more important than others and be able to distinguish between their ‘priority’ and ‘non-priority’ debts.
Although all creditors that are owed £750 or more ultimately have the power to force your company into compulsory liquidation, realistically, this is not a course of action a supplier you owe £1,000 is likely to take.
That’s simply due to the time it takes to go through the process and the costs involved. However, there are creditors that can take action that will really hurt your business. For that reason, you should always prioritise the repayment of those debts.
What are your limited company’s priority debts?
The law gives some creditors greater powers to get their money back. Your priority debts are those where serious action can be taken against the company that will severely impact your ability to run the business effectively. For example, if you don’t act quickly, some creditors may:
- Disconnect the gas and electricity you need to run your business
- Send bailiffs to take assets from your business premises
- Evict you from your business premises
- Repossess your business premises (or repossess your home if the debt is secured against personal property)
- Refuse to provide the essential supplies you need to run your business
- Restrict your access to future finance deals
Given the dire consequences that any of the above would have for your business, it’s important you use the money you do have to make payments and reach agreements to settle these debts first.
Which debts should your limited company pay first?
At this point, it’s very important to note that if your company is insolvent, you should not pay some creditors ahead of others. This is called creating a ‘preference’, as you are making one creditor better off than the majority of other creditors.
That could lead to personal liability for company debts and even disqualification as a director for a period of up to 15 years.
However, if the company is not insolvent, these are the company debts you should make it your priority to repay:
(1) A business mortgage
Commercial and residential mortgage lenders have the right to repossess a property or land without a court order. Lenders are also typically more demanding when mortgages have been taken out for business purposes. If you fall behind on the payments of a business mortgage, the lender can appoint an LPA receiver, who will be able to recover the money you owe by repossessing the property.
(2) Business rent
If you do not keep up with your rental payments for a business premises, your landlord can send a bailiff to the property to remove stock and equipment without requiring a court order. If you cannot make payments, your landlord could even change the locks on your premises to prevent you from gaining access. For this reason, you must prioritise the payment of business rent, and if you do fall behind, you should contact your landlord to let them know you’re having difficulties and try to reach an agreement to pay off the arrears.
(3) Business rates
If at any time you find you are unable to pay your business rates, you should not just stop paying them. Keep paying what you can afford and contact the council to try and come to an arrangement for the rest. If you fail to pay your business rates or do not stick to a payment arrangement you’ve made, the council can apply to the magistrate’s court to make a liability order against you. It can then take action, including sending bailiffs to your business premises.
(4) Gas and electricity
If you don’t pay your gas or electricity bills, you could have your supply cut off in just a few weeks, although by law, your supplier must give you 14 days’ notice before they disconnect you. You’ll usually have to make full payment before the next bill is due. If you have arrears, your best bet is to phone the supplier and ask for a payment arrangement before they take action. That will have to cover the energy you’re currently using and include a payment to reduce the arrears.
(5) Tax liabilities
If you are behind on your Corporation Tax, PAYE, VAT payments or National Insurance contributions, you must contact HMRC immediately to discuss your situation. If you are late to file and pay your tax then you will receive late payment penalties and may have to pay interest on the amount you owe, which will make an already bad situation worse. You could try and negotiate a Time to Pay arrangement. That will give you time to pay the debt at a rate you can afford.
HMRC can employ a number of different strategies to recover an unpaid tax debt.
- Debt collection agency – HMRC may pass the debt on to a debt collection agency. They are not bailiffs so they will not be able to force entry to your business or take goods. Making them an offer to pay by instalments based on what you can afford will put an end to the enforcement action.
- Bailiff action without a court order – HMRC is one of a select group of creditors that does not need a court order to visit your premises and take control of goods up to the value of the debt. If you refuse HMRC enforcement officers entry to your business premises, they could get a court warrant to force access. However, they are more likely to take the matter to county court to get a county court judgement (CCJ) issued against you. If the debt remains unpaid, HMRC can then take steps to force your company into liquidation.
(6) Hire purchase deals and equipment leases
If you have hire purchase deals for company vehicles or lease deals for equipment, these can be treated as either priority or non-priority debts depending on the terms of the agreement and how critical the vehicles and equipment are to your business. In a hire purchase or lease deal, you do not own the goods until the last instalment has been paid. That means, if you fall behind on your payments, the lender may be able to take back the goods and sell them to reduce the debt. You do not have the right to keep the equipment and it’s essential to your business, you should treat hire purchase and lease deals as priority debts.
(7) Major suppliers
If you cannot get the supplies that are vital to your business from another source, you should treat a trade supplier as a priority creditor. You should contact the supplier to explain your situation and ask for more time or make an arrangement to repay the debt. A supplier may give you more leeway than most creditors as they will be reluctant to lose an important customer.
(8) Business overdrafts and loans
If your business regularly goes over its overdraft limit, interest and charges will be added to what you owe. There’s also the risk that your overdraft will be cancelled if the bank suspects you are in financial difficulty, which could make it very difficult to manage your company finances in the future. If you are at risk of exceeding your overdraft limit, you should speak to your bank to try and negotiate an arrangement to pay what you owe over a longer period. It tends to be easier to speak to your bank branch rather than contacting a central debt recovery unit.
Bank loans and overdrafts will either be secured or unsecured, and that’s likely to determine whether they should be treated as a priority debt. If the bank has security over personal assets such as a family home or you have signed a personal guarantee, it must be treated as a priority debt. If the loan or overdraft is unsecured, then depending on your circumstances, it may be a non-priority debt, although that will depend on the terms of the agreement and your company’s ability to access a banking service elsewhere.
What are the non-priority debts of a limited company?
There are also numerous examples of non-priority debts of limited companies. The consequences of failing to pay non-priority debts are less severe. However, all creditors that are owed £750 or more can issue a county court judgement against you (CCJ). If that goes unpaid, they can then issue a winding up petition to force your business into compulsory liquidation.
Examples of non-priority debts include:
- Non-essential business supplies – Debts for business supplies that you could get from another supplier or are not vital to the operation of your business, such as computer accessories, office stationery and cleaning products, need not be treated as a priority.
- Business credit cards – These generally fall into the category of non-priority debts as they are unsecured and your personal assets are not at risk
- Some bank loans and overdrafts – Loans that are not secured by an asset or personal guarantee are generally considered to be a non-priority debt
Part 3: What Steps Can You Take to Manage Limited Company Debt More Effectively?
If you’re facing increasing limited company debts, you must take action rather than burying your head in the sand and hoping for the best. If you fail to make payments on your debts, particularly those priority debts, the consequences can be severe. That’s why it’s crucial you act now.
Keeping up to date financial records and using good quality account software will ensure you’re aware of your outstanding debt and monthly repayments at all times. Your company accountant will also be a good source of advice, as will the insolvency practitioners here at Company Debt.
How to regain control of your limited company debts?
There are numerous strategies you can employ to help you regain control of your financial situation. The most appropriate strategies for you will depend on how flexible your suppliers are willing to be and the type of business you run.
(1) Raise funds to pay your debts
Raising funds to pay your debts might be a case of easier said than done, as a business that’s free from debt represents a far better lending and investment proposition than one that’s struggling. However, there are still a number of options that are worth exploring:
- Borrow from family and friends – This is something you should think very carefully about. Although you may be able to borrow from family and friends at favourable rates, it could put a strain on your relationship. If the business fails and you are unable to repay the loan, that relationship could be irreparable.
- Look for new investment – As an indebted company, any new money you bring into the business is likely to be expensive. An investor who might have wanted 5 percent of a successful business may ask for 25 percent of your business in its current condition.
- Sell non-essential assets – Does your business have assets that it could continue to operate effectively without? Selling buildings, equipment, vehicles or stock you do not need will allow you to free up capital to repay your debts without having to secure investment or external finance.
- Explore alternative funding types – If a lack of cashflow is exacerbating your debt problems, alternative funding methods such as invoice finance could improve your liquidity without adding to your long-term debts.
(2) Reduce your costs
You might feel like you need to reduce your costs to the bare minimum when debt looms over you, but doing so without very careful thought can be counterproductive. It’s where and how you cut costs that really matters. For example, slashing your marketing spend might save you money in the short-term, but if you rely on having a steady stream of new clients, it might make matters worse over the longer-term. Similarly, you might choose to make staff redundant only to find you’re unable to accept larger contracts that come your way.
The key is to trim the fat off your company, not the muscle. You should also use accounting software to list your largest outgoings and forecast what the impact of different cost-cutting options will be before you make any decisions. Here are a few areas where you may be able to cut costs:
- Move premises – Reduce the size of the premises you rent or move to a cheaper area. You could also consider subletting space you don’t use.
- Make redundancies – Consider making non-essential members of staff redundant but be wary of hiring short-term replacements as that can prove to be more expensive over the longer term.
- Reduce your debt repayments – It may be possible to take out a consolidation loan to amalgamate several debts into one monthly payment and reduce your costs at the same time. You should always read the small print on this type of deal very carefully, so you know exactly how much you’ll have to pay.
- Consider refinancing – If you have a short-term liability at higher than the current market rate of interest, consider refinancing in favour of a longer-term deal with more manageable monthly repayments.
(3) Renegotiate the terms of your debts
Contact your creditors, explain the situation you are in and make it clear that you have a detailed plan for resolving it. Tell your creditors you want to repay the debt in full but need to renegotiate terms for that to happen. Most creditors will understand that it’s far preferable to renegotiate the debt rather than letting the business fail, as if that happens, they could get nothing back.
When it comes to negotiating your financial obligations with your creditors, there are a wide range of options available to you. Your creditors may be willing to reduce your monthly payments by extending the term of a loan, defer one or more payments, waive late payment fees and even lower your interest rate.
Your ability to renegotiate the terms of a debt will be based on your current situation, whether you’ve been a good customer in the past, your payment history and your credit record. It will also give you much more leverage if you are in a position to pay off a debt via a lump sum or multiple payments. It’s also important to be proactive. If you approach your creditors before they start chasing you for missed payments, they’re more likely to take you seriously.
(4) Increase your revenue
Of course, increasing your revenue is easier said than done, but there may be some ways you can boost your short-term income to fund your debt repayments and get your business back on track.
- Offer early payment discounts – Rather than waiting 30 or 60 days for an invoice to be paid by a customer, offering a 2-3 percent discount if the payment is made within 7 days could boost your cashflow and improve your ability to make debt repayments.
- Meet with your accountant, bank or financial planner – Share your business plan with your accountant or bank and see if they are willing to introduce you to some of their other clients in return for a small finder’s fee.
- Offer customer incentives – You may be able to increase customer numbers and generate additional income by offering customer incentives. That could be in the form of reduced prices or savings if a certain number of products are purchased.
(5) Improve your credit control and collections process
Nothing affects your ability to make payments to your creditors quite like late payments, and worse still, non-payments from your debtors. Encouraging customers and clients to make payments within the terms you offer, and ideally earlier, is crucial to your ability to repay your debts. You should also carry out comprehensive credit checks and ask for trade references before agreeing to work with a new customer. That will reduce the likelihood of bad debt.
- Invoice quickly and accurately – Just after the sale is one of the most critical periods in the credit control process. Invoicing quickly and accurately while you still have the customer’s attention is key. Your invoices should be addressed to the correct person, submitted in the format requested by the client, be accurate, include your credit terms and a reference number and explain how the payment should be made. We also recommend making a courtesy call to the customer to ensure they’ve received the invoice and check there aren’t any problems.
- State your terms and conditions clearly – Your terms and conditions should be clearly stated across contracts, invoices and order confirmations. You should also inform the customers of your terms and conditions during the sales process. It should include every aspect of your credit control procedure including the action you will take if the payment is late, such as charging interest and passing the debt to a collection agency. You must follow through with this action if the customer does not pay.
- Encourage early payment – If you’re willing to accept slightly lower profit margins in return for early payments, you should offer early settlement discounts that incentivise customers to pay quickly. The discount doesn’t need to be excessive or offered to every customer. In fact, it’s often most effective when it’s offered to those with a record of not making payments on time.
Part 4: What if You Have Limited Company Debts You Cannot Repay?
Despite all your best efforts, there may be times when your company has accumulated debts it simply cannot afford to repay. When a limited company is unable to pay its liabilities when they are due, it’s said to be insolvent. Once a company is known to be insolvent, the company directors have a new range of legal obligations they must meet. If they fail to do so, they could be made personally liable for the company’s debts and be banned from operating as a director for a period of up to 15 years.
Is your company insolvent?
A company director has a legal requirement to understand whether their business is insolvent and take the necessary action if it is. If you are unsure whether your company is insolvent, there are three tests you can do that will help to clarify your position.
- Test 1 – The Cashflow Test
Is your business able to pay its bills when they become due? If not, that’s a clear sign that it’s in a precarious financial situation. There’s also a further requirement to consider whether the business can pay its liabilities in the ‘reasonably near future’.
- Test 2 – The Balance Sheet Test
Are your company’s assets exceeded by its liabilities on a balance sheet, or more simply, does your business owe more than it owns? If yes, then the company could be insolvent.
- Test 3 – The Legal Action Test
Does your company have outstanding statutory demands for payment or unanswered county court judgements (CCJs) against it? If it does, that’s official confirmation that the company is unable to meet its liabilities. This is a clear sign that the company is insolvent.
What must directors do if their company is insolvent?
If you cannot pay your debts and you believe your company is insolvent, there are a number of initial actions you must take to avoid personal liability for those debts and accusations of fraudulent trading. You must:
- Cease trading immediately
- Seek the advice of a licensed insolvency practitioner
- Put the interests of creditors first, rather than those of the company or shareholders
- Keep a clear and well-documented record of the steps you take from the point of insolvency
- Consider the following instalment arrangements and insolvency procedures to rescue the business or close it down in the most beneficial way for your creditors
What options are available if your limited company cannot repay its debts?
Being insolvent is not an untenable situation. There are still a number of options available to you that could save the company from closure. Which option is most appropriate for your company depends on its current financial position, its underlying viability and the action creditors are likely to take.
Time to Pay Arrangement
If one of the debts your company is unable to repay is Corporation Tax, VAT, PAYE or National Insurance contributions, you should contact HMRC immediately. HMRC will chase debts relentlessly and take action to liquidate your business if it believes you’re approaching insolvency. However, the good news is that HMRC may be willing to give you some leeway.
HMRC offers an instalment plan called a Time to Pay arrangement, which gives businesses with temporary tax debts the opportunity to pay their liability over a period of between 3 and 12 months. During that period, you must also file your returns and pay all your ongoing tax bills on time.
Negotiating with HMRC can be daunting, particularly when the survival of your business is at stake. That’s why many directors choose to appoint insolvency practitioners to put together and present their case to HMRC.
If a Time to Pay arrangement can be agreed, you may be able to avoid further late payment penalties and interest charges. You will also buy yourself the time you need to turn your business around without the constant threat of legal action from HMRC.
Company Voluntary Arrangement (CVA)
A Company Voluntary Arrangement or CVA is a legally binding agreement between your company and its creditors to allow you to repay all or a proportion of your debts over a period of 1 to 5 years. For the proposal to be accepted, 75 percent of your creditors (by value) must vote in favour of the CVA.
Once the CVA is in place, all legal action and interest charges from creditors will cease, giving you the time and space you need to repay your debts while continuing to trade. You should also see an immediate improvement in your cashflow, as multiple debts will be consolidated into a single monthly payment.
A CVA can also be beneficial for your creditors. They will generally receive a higher return than if your company was liquidated. Many creditors will even agree to continue working with a business undergoing a CVA as it can be preferable to losing an important customer.
If your company’s debts are such that there’s no viable way for your business to continue operating in its original form, a pre-pack administration could be a better option than closing the company. In a pre-pack administration, the business will be sold as a going concern, often to one or more of the existing directors. They will go on to form a new company that is free from the debts of the old business.
In a pre-pack administration, the assets of the old business must be purchased by the new buyers at a fair price and using their personal funds. That could prove to be a sticking point for some directors. The insolvency practitioner, who controls the process, must also choose the most appropriate buyer for the underlying business. It could be that they decide a trade buyer or another third party is a more suitable option than the existing directors.
Limited Company Debts Do Not Have to Mean the End of Your Business
More than a third of business owners are uncomfortable with the level of debt in their companies, so you’re certainly not alone. If you are concerned about your rising debt levels, do everything you can to keep your business trading and talk to the experts here at Company Debt for a full explanation of the options available to you.
With sound advice and plenty of perseverance from you and your team, you’ll have every chance of turning your business around. If things don’t improve, there are still formal insolvency procedures that we can use to rescue your business or close it down while ensuring all your obligations as a company director are met.
For a free, no-obligation discussion about your limited company’s debts, please get in touch with our team.