In an ideal world, owners of small privately held companies would always separate their business and personal expenses. In reality, this doesn’t always happen, and many owners may be unknowingly indebted to the very company they are utilising to insulate themselves from debt.

This article discusses the dangers involved when the line between personal spending and business spending becomes blurred; and the steps that you can take to restore this distinction; eliminating (or at least reducing) the associated financial risks.

Consider an owner of a construction company. On the on hand, the company itself will have many routine business expenses (fuel, replacing inventory, routine overheads such as insurance etc). Separately, the owner (in their individual capacity) will have personal expenses of their own. Certain expenses – for example the cost of a lunch – could arguably be attributed as either a business or personal expense (depending on the circumstances in which the cost was incurred).

With such an easy scope for overlap, it is easy to understand why many small business owners end up using company bank balances as an extension of their own personal finances.

Afterall, the whole point of owning a business is to earn money from it.

While making money is indeed the ultimate aim of going into business, the major advantage of owning a business through a company is to protect the business owner from the financial consequences of the business failing (so much as is possible). It is better for your company to enter liquidation then it is for you to be personally adjudicated bankrupt.

Unfortunately, taking a casual approach to company and personal spending can risk both occurring. Negating the advantage of running your business through a company and risking experiencing the worst of both worlds.

To guard against such a financially calamitous double whammy, the best course of action is to vigilantly respect the distinction between your company as a legal ‘person’ and yourself as an (actual) person. In practical terms, this means only taking money out of their business in the form of your wages/salary or by way of dividends (which are taken from the net profits of the company).

While the above represents what company owners should do in an ideal world, the reality is that most business owners will, from time to time, use company funds on a personal expense.

Understanding shareholder current accounts

Consider the example of a company owner regularly drawing money from an ATM using a company credit card. The company owner then takes that money and spends it on non-business related expenses over the course of a few weekends. Over time, the company owners acquires the habit of reaching for the company’s money in circumstances when they should be utilising the money that they personally own.

An observer might question whether this is even a problem. After all, the company owner owns the company and the company owns the money. Indeed even the author acknowledges that it is tempting to see the standard methods of drawing money from a company (salaries, dividends) as cumbersome bureaucratic hurdles keeping a person separated from ‘their’ hard-earned money.

As annoying and obstructive as observing these payment formalities may feel, deciding to ignore them changes the nature of a payment from a company to its owner entirely (even if the payment is not made to the owner directly, but simply on their behalf). Such payments are actually extensions of credit – individual loans that closely resemble bank overdrafts.

Taken together, the sum of all these individual loans are legally treated as being debited against the owner’s (notional) ‘shareholder’s current account’ (which functions like a form of overdraft).

The danger of unchecked shareholder current account debt

Unlike a bank overdraft, there is nothing (except the owner’s restraint and the availability of funds) to provide an upper limit on what can be drawn from a shareholder current account.

This can, in combination with other factors, result in the liquidation of the company. If liquidation occurs, the liquidator will scrutinise the shareholder’s current account and demand immediate repayment of any outstanding balance.If not repaid, court proceedings can be issued by the liquidator against an owner in respect of their shareholder current account. This can result in bankruptcy for the owner and personal sanctions for failed director duties. The legal separation of company and owner will afford no protection when years of shareholder current account drawings have been allowed to mount up unchecked.

Mitigating the risk

To mitigate this danger, owners should reflect on the possible consequences of cavalier company crediting and adjust their day-to-day business practices by keeping personal and business expenses strictly separate at all times. Straightforward examples would be to use separate business and personal debit cards as appropriate (leaving the company card at home on the weekend to reduce the chances of acting on temptation).

Effective management of shareholder current accounts is also vital for maintaining financial stability in closely held companies – especially in industries where profit margins can be thin and easily buffeted by unexpected adverse events. As a shareholder, the best course of action is to pay yourself last after expenses.

When personal and business expenses haven’t been separated – say for example if you are caught short at the supermarket or on a large personal expense – thought should be given to how overdrawn accounts might be resolved.

Where sufficient personal cash is unavailable to simply repay an overdrawn amount on the day, owners may instead work with their accountant (or legal adviser) to:

• Declare a dividend that matches the overdrawn amount.
• Issue a shareholder salary to offset the overdrawn amount.

The above methods are only available when the company is solvent and, before utilising either method, it is important that owners involve their professional advisors (particularly accountants) before taking these steps.