Self Funding – An Introduction
For those who wish to retain control over their own business and who do not want to become burdened with a large amount of debt, it is important to look at all the available business financing options, first. It is vital to have a clear idea about whether you intend to finance the business from personal assets or whether you wish to ensure that the business funds itself.
Sole Trader or Limited Company
If it is considered desirable to split one’s personal assets from the business assets, then setting up a limited company is a very good option. A sole trader is not a separate entity to his or her business; therefore, if the business owes money, the lenders can turn to the individual to pay off the debts. Although this increases the risk levels for the sole trader, it does allow individuals to raise finance based on their own assets such as property or previous good credit rating, which will encourage banks to offer a favourable loan rate.
A limited company has the advantage that the person who runs the company is considered as a separate entity to the company itself. Therefore, if the company begins to fail and is in debt, the individual cannot be chased, unless he / she offered a personal guarantee for loans taken out by the company. A limited company will have both shareholders and directors; the shareholders put in the cash and effectively ‘own’ the company and the directors are appointed to run the company.
It is very common for a new business to have the same shareholders as directors; it is also common at the beginning for the company to have only one shareholder investing one pound for a ‘founder share’. In the future, it may be possible to sell more shares to raise additional finance from investors – these would be equity investors and would only be liable for their initial investment. This means that if the business fails, the investors will only lose the value of their investments.
Being a Guarantor
Aside from the possible liability of a sole trader, directors should not be under the misapprehension that they cannot be held personally liable. With a new limited company, banks are generally unwilling to lend a substantial amount of cash, as there is no track record. It is typical, therefore, for banks to request a personal guarantee on any cash advanced. If the business then fails to pay back the loan, the individual guarantor may become liable for the debt, leaving the individual in a similar position to that of the sole trader.
Always read the small print on any loan agreements that you are entering into on behalf of the company, in order to make sure that you do not offer any personal guarantees by which you do not intend to be bound.
- For those who wish to retain control over their business, self-financing may be the best option
- A sole trader can be liable for the business debts, whereas a limited company separates the directors from the business, thus removing the obvious personal liability
- With a new company, it is common for the bank to ask for a personal guarantee which can negate the benefits of a limited company