News

Fund your business with - A directors loan

04/02/2010

Although the economy is showing signs of recovery, most analysts still believe that small firms will struggle to access finance. Injecting money into your business through a director's loan could provide the financial lifeline you need, as Naomi Marks explains

"We're likely to see an increasing number of limited companies using director's loans this year so they can meet their liabilities or fund growth," predicts Huw Davies, corporate adviser for independent financial advisers Baigrie Davies. "The most logical reason for putting money into a director's loan account is to fund expansion, but people also do it to help with cashflow."

A director's loan is typically a personal loan made by a director to their company. Generally, the director deposits a sum into a director's loan account, which the business can access – although they may also forgo their salary as a form of loan. Such loans are often used when commercial loans are unavailable, but they can be an astute way of providing finance.

Pros and cons of director's loans

"At times the business owner can borrow money more cheaply than the company can borrow it," Davies points out.

For example, a business owner could extend their home mortgage to fund a director's loan rather than take out a commercial loan. The latter would typically come at a higher interest rate and may still have to be secured against the director's personal property.

"There's a clear financial advantage in using a mortgage to fund a director's loan," says Davies. "With a personal loan, which has higher rates, the financial advantage is less clear. You might use one when it is the only option open to you."

Director's loans may be for relatively small amounts and short terms – for example, to avoid the bank interest rates associated with an overdraft in a firm's early years. Alternatively, they can be for much larger sums over many years, such as to fund a deposit for new premises.

"The only real drawback is if the business fails, in which case the director becomes an unsecured creditor," warns Davies. "To become a preferential creditor the loan would have to be secured against business assets. Use a lawyer if you're considering this."

Keep records of director's loans

You don't generally need to seek legal advice for director's loans, as firms are not required to document them. "You just need to set up a ledger so you can keep track of what has come in and what has gone out," explains Davies.

"But it is best practice for the loan's terms to be clearly noted, even if it is just in a board minute," he adds. "It lessens the potential for disagreement."

You should seek tax advice from your accountant but, in general, directors can charge interest on the loan repayments, and the business can claim a corporation tax reduction on the sum. However, if directors charge unreasonably high rates it may be seen as income and taxed as such.

Director's loan accounts may also be used by directors to withdraw money from a business which is not a salary or a dividend. Then it is a loan from the company to you. "In this situation, you must pay tax on amounts not repaid nine months after the end of the corporation tax accounting period," concludes Davies.

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