The danger of blurring business and personal funds

| January 4, 2018

Using unsecured personal funds in a business is an issue for many smaller companies and the consequences can be disastrous.

“Many people confuse personal and business assets,” says Jirsch Sutherland Partner, Trent Devine. “But if you’re loaning money to a business you should secure it.”

Devine cites a case he worked on where the businesses’ sole director/shareholder had sold his house and personal assets and put several million dollars into his business without securing the debt.

“The business ultimately went bust and he lost everything and became bankrupt,” Devine says. “If he had taken security over the assets of the company he would have at least walked away with some money, given the significant plant and equipment involved, and avoided bankruptcy. Secured creditors get paid out ahead of almost all other unsecured creditors – barring a few exceptions.”

Mills Oakley Partner Peter Hodges says securing your funds properly provides such a powerful degree of protection it’s astounding that it is not more regularly utilised.

“For example, say someone sets up a business but finds it hard to secure bank funding upfront so they loan their own money into it,” he says. “If an insolvency situation comes up, nine times out of 10 they end up regretting it because all they are is another unsecured creditor.”

Hodges says if they had instead taken reasonably simple steps upfront, they could have granted themselves a security interest in the assets of the company, thereby giving their claim to those assets a higher priority.

“It might only be a specific security interest in a vehicle or piece of equipment but they could dramatically improve their position both in circumstances where there is a problem down the track such as an insolvency event or if the company had a claim against it that presented a risk of an insolvency event being forced upon it,” he says.

Proper documentation is key

Hodges says proper documentation is the solution. “All that is needed is to properly document in the company minutes a resolution that agrees to accept a director’s personal funds and that the company agrees to enter into a loan agreement and general security agreement with the director or the entity of the director advancing the money,” he says.

“A security interest can then be granted by the company in favour of the director over the company’s assets generally as well as over particular assets that the company is purchasing with the loan money.”

There is another benefit to taking this action, Hodges adds. “Say the company is being sued by someone and the director thinks they may lose the case. If the director is a secured creditor, if the loan agreement has been properly drafted and if the security interest has been properly registered, then the director can put a receiver in to sell the assets of the company and pay him back. In which case it completely defeats that claim against the company.”

One of the reasons business people don’t take out this protection upfront, according to Devine, is a lack of funds. “When you first set up a business, money is tight,” he says. “But this is the time you really need to speak to your accountant or adviser and get the most appropriate advice. It may involve an initial cost to put the right strategies in place but this is far better than losing everything.”