Does director's cash keep company solvent?

[AnotherBill]

We have formed a ltd company, and plan to start trading soon. Despite talking to various professional advisors, I remain unclear on one aspect regarding solvency...

...in the early years, if our company fails to make sufficient money to pay overheads, I would like to think we can continue trading by injecting cash in the form of Directors loans. Budgets and overheads will be low so will have no other creditors, and the directors can accept the risk of losing the money they loan to the company.

But if a company trades in that way, constantly in debt to its directors, is it technically insolvent? And if the situation persists year after year must it take further action to restore solvency, perhaps formally writing off the loans from Directors, or raising share extra capital?

Thanks in advance for any words of wisdom.

 

[Scalloway]

If the company isn't making enough money year on year to be able to repay its directors I would question if it is woth carrying on. The point in setting up in business is to make a living from it, not to pour in your life savings until they are gone.

 

[AnotherBill]

If the company isn't making enough money year on year to be able to repay its directors I would question if it is woth carrying on. The point in setting up in business is to make a living from it, not to pour in your life savings until they are gone.

The intention is most certainly to make money, but plans don't always work out, and I like to think ahead to cover other scenarios.

Obviously if it's still looking bleak after a few years we'd want to pull the plug, but I want to understand how we can legally finance it in the early years if it fails to make profit, on the basis that fortune and prosperity may always be just around the next corner. Moreover, if we never turn that corner, I like to think the timing of when to pull the plug would be the directors' decision. But would that decision actually be forced upon us by a statutory need for solvency?

 

[StevensOnln1]

The company would only be insolvent if the director demanded his loan be repaid and the company did not have funds to do so. Thousands of small companies are funded in this way.

Sent from my GT-P1000 using UK Business Forums

 

[AnotherBill]

The company would only be insolvent if the director demanded his loan be repaid and the company did not have funds to do so. Thousands of small companies are funded in this way.

Sent from my GT-P1000 using UK Business Forums

Thanks a million, that's what I figured.

I think I've been confused by the many website 'definitions' of insolvency, some of which appear on convincing-looking websites, boldly stating that a company is insolvent if its debts outstrip it's assets. Taken literally, the loan from Directors is a debt, which got me scratching my head but common sense dictates it must be treated differently from other debts.

Considering your response a large penny drops with a clunk in my brain, as I have seen other definitions of insolvency, being when the liabilities (as opposed to debts) outstrip assets. That I guess is subtle difference, since the Director's loan only becomes a liability if the director wants it back!

 

[StevensOnln1]

A directors loan is a liability and is treated exactly the same as any other debt. A company would be insolvent if it could not pay its debts when they fall due. A director would not usually demand his loan be repaid when the company doesn't have the funds, so the debt would not be due so the company is not insolvent.

 

[AnotherBill]

A directors loan is a liability and is treated exactly the same as any other debt. A company would be insolvent if it could not pay its debts when they fall due. A director would not usually demand his loan be repaid when the company doesn't have the funds, so the debt would not be due so the company is not insolvent.

Then I thank you once again, but regrettably am back to feeling uncertain. Perhaps I am focussing to much on the definition of solvent/insolvent.

Ultimately, and avoiding the word 'solvent', I need to understand for a company financed by money lent by the directors.... If the company's debts exceed its assets, does there come a point where the company is forced to cease trading, or can that always be averted if the directors are willing to continue lending more money to the company so that other debts can be repaid when due?

 

[bovine]

If the director wants to keep pumping in money, the company can keep trading legally.

The big issue as to when a company should stop trading is when the debts are due. If you owe £5000 due to be paid today and only have £1000, technically you are insolvent. If the director pays the company the balance of £4000 to pay, it is not insolvent but now owes the director £4000. As this debt is not due today, the company is solvent again for now. If the director demands the money back in a month and there is no money to pay, then the company is insolvent.

This is by the technical definitions, but the reality can be a bit more "fluid".

 

[KM-Tiger]

Then I thank you once again, but regrettably am back to feeling uncertain. Perhaps I am focussing to much on the definition of solvent/insolvent.

It is confusing. By the strict assets/liabilities definition an awful lot of small companies are technically insolvent, particularly in their early years. But they can carry on trading quite legally, on the grounds that directors loans are not due.

As other have said, many small companies are funded in exactly that way.

From your point of view you need to keep an eye on the risk that the company will never repay your loan if things go badly.

 

[AnotherBill]

It is confusing. By the strict assets/liabilities definition an awful lot of small companies are technically insolvent, particularly in their early years. But they can carry on trading quite legally, on the grounds that directors loans are not due.

As other have said, many small companies are funded in exactly that way.

From your point of view you need to keep an eye on the risk that the company will never repay your loan if things go badly.

Thanks a lot. In this case, whilst the company income is unpredictable and volatile, the overheads are fixed, modest and should remain stable. Hence the directors can make a judgement call, with no nasty surprises, as to how much to invest (ie lose) before calling it day.