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How to deal with sole trader debts?

Being a sole trader, also known as being self-employed, means you are personally responsible for all your debts – whether they are personal or business-related. This can include anything from consumer debt, mortgage repayments, all the way to suppliers, HMRC and hire purchase payments.

This means that you have to pay these debts out of your own income. If you do not pay, the creditors you owe money to could take further action against you personally. If this happens, both your business and personal assets could be at risk. Creditors have the ability to file for county court judgements and failing that, send bailiffs to either your business or personal premises.

Deciding the best way to proceed

There are several ways you can deal with sole trader debts. The most suitable option available will depend entirely on your situation.

You may see continuing with your business and re-financing or setting up a formal payment plan as the best way forward. However, you may not believe the business has a future and wish to enter full-time employement, but still wish to go into a formal or informal repayment plan to repay some of the debts that have accrued.

Individual Voluntary Arrangement (IVA)

An IVA is a formal arrangement between you and your creditors where you can consolidate all your debts into one single monthly payment. As an IVA is a legally binding agreement, it means you have more protection from your creditors who generally will not be able to apply interest charges to your debt or take legal action against you for the duration of the IVA. If 75% of creditors (by value) agree to the proposal, then you will enter into the IVA, usually, for the five-year term paying back your creditors, the amount agreed in the proposal. At the end of the term, providing you have kept to the conditions, any debts left in the IVA will be written off.

Benefits of an IVA

  • It will protect you and against any action from unsecured creditors included in the arrangement
  • It allows you to pay back an amount you can afford each month
  • It provides you with the safety to carry on trading
  • It is an alternative to bankruptcy
  • It covers unsecured personal and business debts (but not student loans, fines or child support arrears)

Drawbacks of an IVA

  • You need 75% of your creditors who vote on the proposal by value to agree to your proposal to enter the IVA
  • An IVA lasts for five years so it is not a short-term solution to your debt problems
  • An IVA stays on your credit rating for six years (from the date it is approved by creditors) which can affect your ability to obtain credit
  • Not all debts are included in an IVA including secured debts such as mortgages and hire purchase
  • There is also no guarantee that your IVA will be accepted
sole trader debts

 

As an IVA is a formal arrangement, it must be arranged by a licensed insolvency practitioner.

Personal bankruptcy

Bankruptcy is sometimes seen as a severe option to sole trader debts, as any significant assets are likely to be at risk. When you enter bankruptcy, assets such as your home or car may be sold if there is any equity available. If the equity can be raised another way, then the Trustee would explore this. Although you can carry on trading as a sole trader, you will not be able to act as a director of a limited company for the duration of your bankruptcy.

Bankruptcy gives you the chance of a fresh start, but it will significantly affect your credit score and it will stay on your credit file for six years. The Official Receiver (OR), or an insolvency practitioner the OR appoints to act on their behalf, will serve as trustee in bankruptcy, dealing with creditors and the sale of significant assets.

You can either declare yourself bankrupt, or a creditor who is owed money can petition to have you made bankrupt through the courts. In both situations, you would need to owe £5000 before bankruptcy can be an option. With the new online process, it is now much easier to apply for bankruptcy.

Benefits of personal bankruptcy

  • It can provide you with the opportunity for a fresh start
  • In most situations, you will only be in the state of bankruptcy for a year before being discharged
  • The new online process makes it simpler to apply for bankruptcy and in most cases, you won’t have to go to court

Drawbacks of personal bankruptcy

  • Your assets are at risk, particularly any high-value assets such as a property or an expensive car
  • It can sour relationships and any goodwill with creditors who may not be happy as they are likely to receive little or none of the money they are owed
  • It stays on your credit file for six years, affecting your ability to borrow money in future

An informal deal

An informal deal, such as a debt management plan, can be an alternative to bankruptcy or an IVA for businesses who have short-term cash flow issues or a small number of creditors. These are not legally binding and can be with some or all of your creditors.

You can add the debts of some or all of your creditors into this type of agreement, but it is worth noting that interest and charges will not be stopped unless you make a separate arrangement with your creditors.

You should never overpromise the amount you can pay and you will need to provide realistic timescales, explanations of your situation, as well as keeping an open communication channel with your creditors.

Benefits of an informal deal

  • It costs less in fees than an IVA or a bankruptcy
  • It can be stopped at any time so if your situation improves you can come out of the deal
  • Pressure from your creditors normally disappears when you are in an informal deal providing you stick to the terms agreed.
  • If you use a debt management provider, then they will deal with your creditors on your behalf

Drawbacks of an informal deal

  • It is not seen as a solution to long-term cash flow issues for your business, and offers no protection from creditor action
  • If a default notice has been issued against you, it will stay on your credit file for six years
  • Interest is not likely to be frozen so that debt will continue to grow despite your agreement with your creditors
  • It can last indefinitely although in practice creditors sometimes lose patience and pull out of the agreement
  • It can have a detrimental impact on your ability to obtain credit in future

Time to pay arrangement (TTP)

A TTP arrangement is only for use with HMRC debts. TTP arrangements were designed to help viable businesses which are facing temporary cash flow problems pay off their tax liabilities on a monthly repayment basis, although they are an agreement to repay debts, they are not a formal arrangement like an IVA.

TTPs usually last for between 6 and 12 months and they will allow your business to negotiate a longer term to pay its tax bill. All types of businesses can use a TTP arrangement to deal with their tax bills, but you will need to put together a proposal which shows why a TTP will be beneficial for your business.

Re-finance

If you own business assets such as equipment or vehicles, it may be possible to arrange to refinance them to inject cash into the business. Similarly, if your own home has value in it, it may be feasible to arrange to increase your mortgage. However, in either situation, you need to be satisfied that your business is viable as simply pumping cash into it when it is loss-making, will not improve the situation in the long term and you may be worse off.

For businesses struggling with cash flow but who have lots of unpaid invoices, invoice finance could be a very viable option. This allows you take an advance based upon the value of your invoices. Factoring companies will assess the situation first before making any decisions but it can be a finance option to help the business.

In summary

Sole traders do not have limited liability, which means that the business is not classed as a separate entity and you are personally responsible for any business debt incurred. Owners of a sole trader business can be held personally liable for business debts, so personal assets such as houses, or cars can be used to pay business debts. There are recovery options available depending on the amount owed, however, business debts can lead to personal bankruptcy.

How we can help

If you are worried about creditor pressure affecting your business and potentially the finances of your business leading you into personal bankruptcy, it’s important to act as quickly as possible. We can help you assess what will be in the best interest of both your personal and business finances. We offer free face-to-face consultations and operate nationwide.

Authored by Ruth Jacks

Ruth Jacks

Licensed Insolvency Practitioner & VA Department Manager

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