Debt Options for Self-Employed & Company Directors

Starting your own business, or becoming self-employed, is an ambition for many people. There’s an obvious attraction to being your own boss, having more flexibility over your working life, and potentially earning a living from something you’re passionate about.

But self-employment or running a business can be financially challenging even when the economy is growing or relatively stable. Around 60% of new businesses fail in the first three years, mainly due to issues with budgeting, cash flow and costs including tax. Understanding the financial side of your self-employment is essential if you want it to be sustainable.

The challenges get much tougher if you’re self-employed or running a business during an economic downturn, especially if it’s caused by an unexpected event such as the Covid-19 pandemic. The impact of coronavirus has fallen particularly hard on the almost 5 million self-employed people in the UK. And the implications of what business owners have done to survive, including taking on more debts, will continue to hit companies financially over the coming months.

Even before Covid-19, studies showed that self-employed families can be nearly twice as likely to be behind with a household bill, and are more likely to be in poverty than those in full-time employment.  This means freelancers, contractors and smaller businesses may have increased problem debts just to survive, or set themselves up for unexpected issues in the future.

Solving your business debt problems can be particularly traumatic if you’ve achieved your dream of becoming self-employed or setting up a company. It’s important to remember that many business owners can fail due to external circumstances, and the priority should be to ensure your future rather than dwelling on the past.

It’s never too late to start sorting out your debt problems, whether you’re self-employed or a company director responsible for trying to save your business and the jobs of your staff. Our focus at Debt Buffer is to help you find the right way back to financial security, so this guide will look at how self-employment and business debts impact you as an individual, and what you can do to resolve your situation.

Types of self-employment and debts

There are lots of different types of self-employed work, including freelancing, independent contracting, or as a season or temporary worker. Or you might be a business owner running anything from a charity, to building a multinational empire. But self-employment in the UK is usually split into the following three categories for legal and tax reasons:

  • Sole trader: It’s quick and simple to register as a sole trade to work for yourself. You will be personally liable for any losses or debts.
  • Partnership: You need to have a minimum of two people with responsibility for the business, and each person will have income and liability based on their share in it.
  • Limited company: This makes the business a separate legal entity from the people running it and requires you to follow more rules, including registration with Companies House.

A debt solution which might be perfect for a sole trader might not be the best fit if you’re a company director, so it’s important to understand the options that apply to your specific situation. And what the implications will be for both you personally, and your business, going forwards. Some of the debt options available may have an effect on your self-employment for longer than you might expect.

How business debts can impact you personally

The split between personal and business debts can mislead you into making mistakes with some serious implications. While it’s relatively clear for sole traders, it can become more complicated for company directors.

As a sole trader you’re personally liable for all of your business and personal debts. This includes if you’ve traded under a business name, employed people, or have ceased trading. Taking out credit for your business secured against personal assets such as your home can put it at risk if you’re unable to make your payment commitments.

If you’re a director of a limited company, there is more separation between personal and business finances. But it doesn’t absolve you of responsibility in specific situations. For example, you are not liable for the repayment of company VAT tax debts, unless the failure to pay is deemed to be deliberate and the company is either insolvent or will be soon.

The two major issues for company directors will be if you have taken on debts with a personal guarantee, or make use of director’s loans.

Personal guarantees can be required for credit including bank loans and overdrafts, especially for new businesses with no trading history. In this situation, one or more directors will agree to personally repay some or all of the debt if the company is unable. Most personal guarantees enable creditors to call in debts if the business is in arrears or has received defaults or CCJs rather than requiring insolvency to act. Typically, these will be unsecured debts and you should speak specialist advice for your specific circumstances.

Director’s loans refer to money paid by your business to you or other close family members which isn’t for salary, dividends, expenses, or for any amounts you’ve previously paid into or loaned the company.

These amounts need to be recorded, and tax is due on director’s loans depending on the amount borrowed and any repayments. There are different responsibilities for both you, and your business depending on the sum loaned, so you need to check both the HMRC rules and with a financial advisor to ensure you don’t encounter an unexpected tax bill.

Coronavirus and credit – the implications of Covid-19 support and debts

Due to the Covid-19 crisis, the UK Government released some measures to help the self-employed and small businesses to continue to operate.

The Self-Employment Income Support Scheme (SEISS) provided grants if you were self-employed as an individual or member of a partnership, and your business was adversely affected due to coronavirus.

Applications for a first SEISS grant closed on 13th July 2020, and enabled you to claim 80% of what you would have seen in trading profits for three months, based on your average over the last three tax years, capped at £7,500. A second grant closes for applications on October 19th, 2020, and allows you to claim for 70% on the same basis, and capped at £6,570.

The important thing to note is that the SEISS grant payments do not have to be repaid. But they are subject to both Income Tax and self-employed National Insurance.

While some businesses were also eligible for grants and other support, including the Small Business Grant Fund, the main focus was on providing the Coronavirus Business Interruption Loan Scheme (CBILS), and the Bounce Back Loan Scheme (BBLS).

The Bounce Back Loan Scheme was designed to help small and medium-sized businesses to borrow from £2,000 to £50,000 with no interest or fees for the first 12 months. The government guarantees 100% of the loan and the interest rate after the first year will be 2.5% for a term of six years, with no fees for early repayment.

If you’re a sole trader, then you can withdraw this money from the business without triggering any tax payments, as this is based on profits. However, it gets more complicated if you are a company director as the money is provided as ‘working capital’ to keep your business operating as normal, so you should check with a specialist advisor before using the BBLS to cover a drop in dividends or provide a director’s loan to yourself to cover lost earnings.

The CBILs financial support is aimed at larger businesses, with a maximum limit of £5 million for up to six years and no interest for the first 12 months. Again, it’s important to check with a specialist advisor before deciding if you can benefit from a loan of this size.

Can you get a DMP if you’re self-employed?

Debt Management Plans (DMPs) are designed to be open to everyone, and you can get a DMP if you’re self-employed. The debts it will cover will be personal non-priority credit, including bank loans, overdrafts and credit cards.

If you’re self-employed, you can also include a business credit card, overdraft or loan in your DMP. But priority business debts to HM Revenue & Customs won’t be included, such as tax arrears.

When you’re including business accounts in a DMP it’s important to understand what limitations you’ll face if you’re taking out new credit. A Debt Management Plan isn’t specifically recorded on your credit history, but any missed or defaulted payments will affect your score and access to future credit. And you may find creditors issue you with defaults after your DMP has started, as you’re now paying reduced amounts towards your debts.

You can choose to use a free debt charity, a fee-charging private company or to create your own DMP. If you’re self-employed, you’ll need to provide a record of your average earnings by either supplying bank or tax statements, or a signed report from your accountant. And it might be recommended or required to contact Business Debtline for free business-specific advice before setting up an agreement with a DMP provider.

For more details, take a look at our detailed guide to Debt Management plans

Can you go self-employed during a DMP?

There’s no formal rule to prevent you switching to self-employment if you already have a Debt Management Plan in place. Obviously, you’ll need to still be able to meet your monthly repayments, and it’s important to speak to your DMP provider for advice before starting your own business.

Becoming self-employed at any time can be a risk, but you’ll need to prepare even more carefully with a DMP in place. If you struggled with debts previously, it’s likely you’ll have a poor credit score, which will limit the offers and availability of financial products and services. That can be a challenge, particularly when you’re just starting out and might need to invest in equipment, premises or advertising your products or services.

Generally, smaller credit items such as mobile phone contracts are less of an issue, and the effect of the missed and defaults payments will decline over time.

Some DMP providers will ask you to avoid taking on further credit without their permission, so you may need to look at switching if you can’t avoid some extra debt while you’re starting out on your own.

Being within a DMP doesn’t restrict you from making any changes to your business, such as moving from a sole trader to starting a partnership or Limited Company.

Ultimately, it’s down to how well organised and prepared you are. Although if your business plans reveal you have savings tucked away, it’s likely your DMP provider and creditors will recommend using these to pay off your existing debts first.

Can you get an IVA if you are self-employed?

Individual Voluntary Arrangements (IVAs) were originally designed for businesses as an alternative to bankruptcy when they were introduced in the 1986 Insolvency Act. The idea is that businesses can potentially bounce back to success and repay creditors more money under an IVA.

An IVA is a legally-binding agreement with your creditors which is mediated and managed by a licensed Insolvency Practitioner (IP). It’s available to anyone in England or Wales who has at least £6,000 in debt across two or more creditors, and can afford monthly payments of typically £80 or more. A Trust Deed is often recommended as an equivalent for anyone in Scotland, but this will stop you from acting as a director of a company, for example.

As with a DMP, you’ll make one monthly payment which is distributed between your creditors. An IVA will typically last for five years, with a final year of additional repayments if you’re not able to release any equity from your home. It will also appear on your credit file and the public Insolvency Register. But at the end of the arrangement, any unpaid debts are written off.

If you opt for a self-employed IVA, it’s likely you’ll be able to keep all of your assets, including your property if you’re a homeowner. Generally you’ll need to keep all the tools and equipment required for your work to be able to repay your creditors, although if you have particularly valuable business or personal assets which are non-essential, such as an expensive luxury vehicle, you might be asked to replace it with a cheaper model and contribute the difference towards your IVA.

IVAs are available whether you are a sole trader or in a partnership. And unlike bankruptcy, you are completely free to become or remain a director of a company. A self-employed IVA will also be designed to take into account the fact that your payments might need more flexibility regarding your income. And although you will need the permission of your IP to access more than £500 of credit during an IVA, it will tend to be slightly more flexible than if you were in a standard IVA for purely personal debts.

You can find out more about how IVAs operate and what restrictions will be placed on you in our dedicated guide to Individual Voluntary Arrangements.

Can you go self-employed during an IVA?

There is no legal restriction against starting a new business during an IVA. But as with a DMP, you’ll need to be extra diligent about considering the implications and downsides.

Entering into an IVA will lower your credit score even further. That’s not a problem if you’re already missing payments and defaulting, as the benefit of resolving your financial issues will outweigh the negative impact on an already damaged credit history.

But it will mean that it’s much harder to obtain credit, business bank accounts and other financial services. And with an IVA clearly marked on your credit history, it will be harder for lenders to ignore.

Any potential change to your employment status will need to be discussed with your Insolvency Practitioner, and they’ll be able to advise you based on your individual circumstances.

Self-employment and bankruptcy

Businesses and individuals can be forced into bankruptcy by creditors, or it can be a positive choice to deal with debt problems. While declaring yourself bankrupt has serious consequences, it also has some advantages, including the relatively short period before you can make a fresh start. However, there are specific areas of importance if you’re self employed or working as a Director of a company.

Some of the advantages of making yourself bankrupt include the fact you can keep a reasonable amount of your income, and the things you need for everyday life and work. Creditors will stop chasing you, and will also have to halt most types of court action. And after the agreed period, you will be ‘discharged’ and won’t have to repay any debts covered by your bankruptcy.

If you own a business, and you’re made bankrupt, a bankruptcy trustee will take over the rights, and normally it will be closed, employees will be dismissed and any assets will be sold for the funds to be distributed among your creditors.

During the bankruptcy, you will not be allowed to act as a company director without permission from the court, be involved in setting up, promoting or managing a limited company (again without express court permission), and if you switch to being self-employed or trading in a partnership under a different business name, you’ll need to share the name of the bankrupt company name with everyone you deal with.

If you break those restrictions during the bankruptcy, it’s a criminal offence. You could also have a bankruptcy restriction order made against you, which restricts your financial and business dealings for up to 15 years. If your business debts or other financial behaviour also results in being banned or disqualified from being a company director, this will also apply for up to 15 years and you’ll need to get court permission to become a company director while disqualified.

Sole traders can start trading again as before. You will find it very difficult to obtain any credit during, or immediately following a bankruptcy. Plus, you may find it more difficult to freelance or contract in certain industries, such as financial industries, gambling, private security and other regulated industries.

Can you be self-employed after bankruptcy?

You can work as a sole trader or member of a partnership during and after bankruptcy without any problem.

After a bankruptcy, it’s possible to become a Company Director again. This assumes you don’t have any bankruptcy restriction order against you.

But it will affect your ability to obtain credit, business bank accounts, and other services requiring a credit check. A bankruptcy will be visible on your credit history for six years from the discharge date, and banks will ask you to disclose if you’ve ever been bankrupt.

Bankruptcy restriction orders and company director disqualification can both prevent you from being a director of any company registered in the UK or that has connections with the UK, or being involved in forming, marketing or running a company for up to 15 years. Breaking this can result in a fine or prison sentence.

Debt Relief Orders and the self-employed

A Debt Relief Order is a cheaper alternative to bankruptcy for those with a low income, little in assets, and total debts of £20,000 or less. You’ll have restrictions placed on you for 12 months, after which any unpaid debts will be written off.

There’s no specific DRO for the self-employed, just the standard debt solution available to anyone that meets the eligibility criteria. You can include certain small business debts including money you owe to employees, debts to customers who paid for goods or services which you were unable to supply, and debts to supplies.

As with bankruptcy, if you’re self-employed as a sole trader or in a partnership, then you can enter into a DRO and continue working.

You’ll also have the Debt Relief Order recorded on your credit reference file, and the Individual Insolvency Register. If you want to take out credit of £500 or more you have to tell lenders that you have a DRO in place.

If you’re a director of a limited company, you will not be able to enter into a DRO. And during the Debt Relief Order, you can’t run a business in a different name without telling everyone the name used for your DRO, you can’t become a company director, and you cannot be involved with the promotion, management or formation of a limited company without court permission.

After your Debt relief Order has finished, it will remain on your credit history for six years, and some lenders and banks will ask if you have ever been made bankrupt or had a DRO when you apply for a mortgage, business bank account or other services.

Time To Pay Arrangements

The debt solutions covered above generally focus on helping anyone self-employed deal with unsecured and non-priority business payments. But what if there’s a problem paying business tax arrears to HM Revenue & Customs?

If your company is typically viable and profitable, but experiencing a temporary issue it’s possible to spread upcoming payments or settling arrears over a longer period for corporation tax, VAT and PAYE.

You’ll need to present HMRC with a realistic proposal of what you can afford to pay, including sales and cash flow forecasts for at least six months and any plans for cutting costs to put the savings into repayments.

If it’s accepted, your Time To Pay arrangement can last as long as 12 months, although 3-6 months is more typical.

Should you close your business and wind things up?

It can be heart-breaking to consider closing a business you’ve spent years building. But it can also mean you can plan how the company or self-employment is wound down, allowing you to look after your assets and responsibilities with as little disruption as possible.

As a company director, if all your business debts were due immediately and couldn’t be paid, you’re probably trading whilst insolvent which is a civil offence under the Insolvency Act 1986. This means if your debt is greater than £750, or you’re violating the terms of a loan agreement, as a company director you could be convicted of wrongful trading. These laws have been temporarily suspended due to Covid-19 from March 1st, 2020 until September 30th, 2020, but this is a small amount of breathing room to turn your business around.

So you may decide it’s time to go into liquidation with a licensed insolvency practitioner, voluntary administration which protects the business with a court order which it is restructured, sold or wound down, or a Company Voluntary Agreement which is similar to a personal IVA, allowing you to freeze debts and interest while debts are repaid over 3-5 years.

For sole traders, if you’re insolvent then you may choose to opt for bankruptcy or make a final settlement offer to creditors. By opting to go bankrupt, rather than having it forced on you, it gives you more time to organise and prepare for the change in circumstances. Otherwise, you might find your debts are called in immediately with no employment or income.

The alternative, if your business is starting to recover, would be to negotiate with creditors for more time to pay, or look at a debt solution such as an IVA.

But the most important thing to remember is that by tackling your business debt problems, it can enable you to recover more quickly, and potentially start a new company in the future with the benefit of experience.

Self-employed debt solutions – Your next steps

With any debt problems, it’s better to act now rather than put things off. The earlier you start resolving your financial issues, the sooner you can have an affordable solution in place. And that’s particularly true if you run a business.

Not only can the requirement to organise a business budget, and possibly forecasts, add time to the process. But it will also minimise the disruption to employees, supplies and customers. And that’s very important if you intend to continue working or trading with the same people in the future.

In most cases, a Debt Management Plan, or Individual Voluntary Arrangement will provide the best solution for self-employed debts. They’re designed to be flexible, or be particularly useful for businesses, so you’ll have less restrictions while they’re in place.

For sole traders and partnerships, Debt Relief Orders and Bankruptcy can be worth considering as a solution if your debt pressure and worry is an increasing problem, and it’s unlikely you’ll be able to make even reduced payments for the foreseeable future. The situation is slightly more complicated for company directors, but it’s still possible to go through bankruptcy and set up a limited company in the future.

With any debt solution, particularly one that crosses over personal and business debts and responsibilities, it’s vital to speak with professional debt advisers, and make sure you understand exactly what will be involved during and after any process. If you let creditors know that you’re working through a solution by using our DebtBuffer letter templates, it will reassure them about future repayment, and should mean they stop chasing and hassling you as much. Which means you can focus on improving your business and moving forwards.