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You would be hard pressed to find a small business owner who has not lent money to their business

What happens when business owners use their own money in the business?

Most small to medium business owners will tell you they went into business to provide for their family, in greater flexibility, time, increased resources, and leaving a legacy.

Like most long term plans, building a self sustaining business takes time; time to mature, time to stabilise in the market, and time to return the capital invested.

To achieve this, the majority of business owners use debt and overdraft facilities as ongoing business tools.

And these types of financial tools can quickly work against you and your family if you're unprepared.

Read in this article:

The risk of lending your own money to your business

Most business owners starting out use their own capital to fund start-up costs and effectively lend the business their own funds.

Over time, you'd be hard pressed not to find a business owner who hasn’t deliberately left unclaimed wages and profits in the business to maintain liquidity and help it grow.

These accumulated funds are usually referred to in accounting terms as, The Directors' Loan Account.

What is a Director's Loan Account (DLA)?

The Directors Loan Account is an accountancy term that usually refers to the money the owner/directors has loaned to the business.

  • Amounts owed to the director from the company are recorded in the company’s financial records as a creditor, while
  • Amounts due from the director to the company are recorded as a debtor.

Warning: The Director's Loan Account is usually unprotected

Directors' Loan Accounts are usually considered a general unsecured debt and not considered a priority debt and do not have special creditor status or special rights to be paid out first if needed.

This means upon the unexpected death of a director/owner, these funds may be last in line to be repaid from the business cash surplus, or ultimately the business assets may have to be sold to return that debt to the directors/owner estate - therefore crippling the possible sale value of the business as an ongoing viable business entity.

The hierarchy of Who is paid first during a forced business debt repayment

When a business is closed due to the death of an owner (or voluntary liquidation), there’s a strict hierarchy to be followed about which creditor to the business gets priority for the repayments of their debts.

Creditors are usually ranked as secured or unsecured and the priority of payment in liquidation are as follows:

  • 1st to be paid — the legal costs of liquidation
  • 2nd to be paid — the Secured Creditors
  • 3rd to be paid — the Priority Unsecured Creditors (ie: employees)
  • 4th to be paid — the Unsecured Creditors (including the director's loan account)

Know the class of your business creditors

A Secured Creditor holds a security interest, such as a mortgage, or a registered security interest over some or all of the business assets to secure a debt owed by the company.

  • These lenders will usually always try to capture the director's home as security through a mortgage or a Director's Personal Guarantee.
    • This is often done by offering a ‘full business lending package’ with EFTPOS facilities and a home mortgage with a business overdraft facility - all deliberately linked to the mortgage over the director's home.
  • This at-call loan facility structure (some might say predatory) has seen the ruin of many modern small businesses.

Pro Tip: At-call loan facility contracts usually have a listed trigger event specifying that a death or disability of a director/owner/guarantor is deemed a mandatory notification to the funder and triggers an automatic call up (repayment) of the debt in 7 to 30 days.

An Unsecured Creditor does not hold a security interest in the company’s assets.

  • Unsecured creditors could be trading partners that supplied goods or services to the business and can also include the ATO when there is tax debt outstanding.

Pro Tip: Employees are a special category or class of unsecured creditors. In a liquidation, outstanding employee entitlements are paid before the claims of other unsecured creditors.

Searching the government's Personal Property Security Register

If the creditor wants to ensure their security interest over personal property other than land is enforceable and given priority in insolvency, they often register the security on the Personal Property Securities Register (PPSR).

If you're considering going into business with another person, lending money to or buying valuable goods from an individual, you can search the government's PPSR here to check if anyone holds a registered security interest (other than a mortgage over land) on the company’s assets or individuals personal assets. 

  • Failing to register your security interest means you’ll be at the end of the queue if there’s some money to recover from a business after the death (or perhaps disability) of a director/owner of a business.

Remember: Business debts do not die with the director

Upon the unexpected death of a director/owner, the guarantees and loans do not die at the same time but require payment upon demand by the creditor.

  • The obligation to repay is inherited by the other director guarantors or your family (at the most stressful time of their life)
  • And there is the problem.

The end result is usually the grieving family are left responsible for any unpaid business debts and usually never sees returned ‘the money owned by the business to its owner’

What solutions exist for you today?

It's important to begin to understand your creditor position and whether you need a fresh business funding strategy to reduce the risks to you and your family.

  1. The fastest and most cost effective way to protect your business debt is by using personal insurance to insure the life and health of a director/owner so that in the event of an unexpected death or disability, there are sufficient funds to pay out the balance in the Directors Loan Account to their family or the estate. (This can also be a useful immediate fix while you look for ways to detangle your liabilities over time).
  1. Don't sign Directors Guarantees without first understanding the full ramifications of what you're signing. Consider keeping a professional register of all Directors Guarantees you do sign and keep a copy of that guarantee contract along with the register list.
  1. Always separate your business debt from your personal debt. Where possible, don't use your home as cross-security for business debt where possible.  We can help you refinance your home to a separate funder from your business funder and replace your business overdraft account from a traditional at-call loan facility to a term loan (usually 20-year term) that is not automatically called up for repayment upon a disability of a director/owner.
  1. Speak with your accountant about restructuring your affairs for asset protection.

Getting your money back out of your business when needed has always been complicated. Not being able to get it back at the time when you're family needs it the most, is an avoidable situation with some simple prior planning.


author pic drew browneDrew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses.  He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.

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