The thought that your own finances might come under threat if your company gets into difficulty is naturally a worry for any owner or director. And while you may be protected from having to take personal responsibility when business debts mount up in some circumstances, that’s not always the case.
It’s useful, then, to be clear as to the extent of the protection that’s in place, and to understand when directors might be personally liable for company debts.
Can a director be held liable when a business goes bust?
This depends primarily on the type of company we’re talking about. A director of a limited company generally enjoys protection when it comes to personal liability for its debts.
There are some important exceptions to note though. They include:
- Where the director signed a personal guarantee (i.e. for a loan).
- When business debts are a result of fraud.
- Where the director has been found guilty of director misconduct.
- Where the director has overpaid themselves from company funds.
- The company has continued to pay shareholder dividends even when it’s insolvent.
- When company funds have been used for non-business activities.
However, companies set up as sole traders and partnerships – as many self-employed businesses are – don’t benefit from corporate protection. Here, the individual(s) and the company are considered the same legal entity.
Sole traders vs partnerships: liability for business debts
The absence of limited company status leaves sole traders and partnerships personally responsible for any debts that mount up.
With no legal distinction between the individual(s) and the company, creditors can access the personal assets of partners and sole traders in order to recover unpaid debts. This means sole traders and partnerships risk personal bankruptcy in the event of being unable to repay company debts.
The main difference between partnerships and sole traders is the number of people who are liable for the company debts. While a sole trader can employ other people, only they can have ownership of the company, and they are fully responsible financially.
If more than one person has ownership, it becomes a partnership. The people who share ownership in a partnership are jointly and separately liable for the company debts.
How can company liquidation affect my credit rating?
Again, limited companies offer a lot more protection. Credit agencies will usually hold separate records for businesses and individuals, which means that changes to one won’t affect the other and a liquidation won’t show up on your personal credit record.
There are some exceptions, however, such as when you’ve provided a personal guarantee.
Sole traders can’t go into liquidation. The insolvency routes available are the personal options, such as bankruptcy, which will show up on your credit record.
If you’re a sole trader and your personal credit rating is poor, it will likely affect your chances of getting a loan for your company. Similarly, unpaid business loans will have an impact on your personal credit rating.
Unlike sole traders, partnerships can usually be liquidated. However, as with sole traders, directors are personally liable for debts and a liquidation will likely show up on their credit record.
If a company is dissolved can it affect your personal credit rating?
If you’re a director of a limited company, your personal credit rating won’t be affected by any kind of corporate insolvency proceedings that the company goes through. Again, there are circumstances where that protection is lost, as outlined above.
Dissolution doesn’t apply to sole traders, but it is relevant to partnerships.
A partnership is dissolved automatically if one of the partners dies or goes bankrupt, while it can be voluntarily dissolved too.
This doesn’t necessarily affect your credit rating. However, any unpaid debts left after a partnership is dissolved will likely show up in the directors’ personal credit ratings, making it harder to secure affordable credit in future.
How to protect your personal finances if you own a business
The biggest step you can take to protect your personal finances as a business owner is to set up as a limited company. This creates a legal separation between your business assets and personal assets, protecting your own finances from the effects of company debt issues.
Setting up as a limited company is relatively simple. There’s a useful step-by-step guide on the UK government website here.
If you’re in partnership with someone, setting up as a limited liability partnership also provides a degree of protection, albeit without the vital legal separation between business and personal assets.
With no such protection for sole traders, it’s very much about being proactive and taking preventative steps.
Insurance options include income protection, which could help you cover costs if you are unable to work, and professional indemnity and public liability insurance, which can protect you against claims you may not be able to afford to pay yourself.
A decent accountant or financial adviser can help you keep your finances on track, as can day-to-day habits such as budgeting and building up an emergency fund.
» MORE: How to identify business risks
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