When you take out a loan in your business name, you probably plan on having enough steady revenue to cover the payments. When the unexpected happens — sales drop off, expenses skyrocket, or you deplete your rainy day fund — your business may not be able to shoulder the burden the way you’d hoped.
If your company can’t pay and ends up defaulting on the loan, you as the owner might be held personally liable for the repayment. However, every situation is different, and personal liability is not automatic. It will depend on the entity type you choose to operate your company and whether you agreed to be responsible for repayment when you first took out the loan.
What Does It Mean to Be Personally Liable?
When you are personally liable for a business loan, it means that the lender can demand repayment from you as an individual, separate from your company. They may try to recover their losses by:
- Sending you bills and invoices
- Submitting adverse reports about your account to the consumer credit bureaus while you are in default
- Turn your account over to a third-party debt collection agency
- Take you to court and try to get a judgment in their favor. The court could then order you to repay the loan or give the lender the right to garnish your wages or your bank account.
- Repossessing assets that were put up as collateral
How Your Business Structure Affects Your Liability
Certain business types have inherent protections that shield you as the business owner from personal liability, while others don’t.
If you haven’t formally established your firm as a separate legal entity, it’s considered a sole proprietorship. You and your business are interconnected, meaning no distinction would protect your assets as an individual.
With a sole proprietorship, you’re liable for the debts your business incurs. Your creditors could go after your house, car, or other property if your business lacks adequate assets to satisfy the debt.
A business that two or more people own is considered a partnership. The amount of personal liability you have for business debts will depend on the specific partnership type you’ve formed.
- General partnership — When two people are in business together, even if they created no formal entity, it is considered a general partnership. General partners are personally liable for their business obligations.
- Limited partnership — A limited partnership includes one or more limited partners and one or more general partners. A general partner is held accountable for outstanding business loans, while a limited partner is not.
- Limited liability partnership (LLP) — When you set up an LLP, the limited partners are shielded from personal liability. In certain states, an LLP will need to have at least one general partner who can be held personally liable if necessary, and some states apply liability protections only to negligence claims — not to business debts.
The purpose of an incorporated business entity is to limit its owners’ personal financial accountability. Corporation owners, or shareholders, do not have to personally pay back an unpaid business loan if they managed the business properly.
Unless there was a commingling of funds or a shareholder agreed to be held liable for the loan, the only way a creditor can recoup their funds is through the corporation’s assets.
Limited Liability Company (LLC)
Owners, or members, of an LLC, have much the same legal protection as shareholders in a corporation. Members will generally not be held liable for LLC debts unless they improperly mixed personal and business funds or offered a personal guarantee for loan repayment.
What Is a Personal Guarantee?
Even if your business entity is set up to protect you from personal liability, your bank may ask you to make a personal guarantee — a pledge that you will pay the funds back if your company can’t. This is especially common if your small business doesn’t have the solid financials or credit history it needs to stand on its own.
High personal credit scores and possession of non-business assets that you can use as collateral for the loan will strengthen your personal guarantee — and your loan application in general. Putting your home or other property on the line can feel like a gamble, but this is often the only way for small business owners to acquire a traditional bank loan.
Reducing Your Personal Liability
What if you don’t have the resources to pay for your company debts personally? Thankfully there may be a way for you to reduce or even eliminate your personal liability. Strategies to consider include filing for bankruptcy or attempting to renegotiate your debt.
Filing for Bankruptcy
If you qualify to file for Chapter 7 bankruptcy, your individual debts will be discharged, and you will not have to pay for your business-related debts personally. You will likely lose assets and have difficulty acquiring additional funding while the bankruptcy is on your credit report, so weigh your options carefully before filing for Chapter 7.
Renegotiating Your Debt
The lender trying to secure repayment may be open to negotiations if it becomes apparent that they will not receive the loan’s entire outstanding balance. Getting a partial payment is better than no payment at all, so lenders are sometimes willing to reduce a borrower’s personal liability.
The lender may be willing to:
- Offer a balance reduction — Creditors will sometimes forgive a portion of a debt in exchange for a smaller lump sum payment upfront.
- Renegotiate the loan repayment terms — A lower interest rate or a longer payback duration could be enough to bring your monthly payments down to a manageable level.
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