Shareholder Loans
In a family or closely held business it is relatively common for shareholders to loan money to the company. Often times, however, documentation of such loans is sparse or non-existent. This lack of formality can lead to a loan being recharacterized as a capital contribution. Capital contributions are often difficult to recover if the business has to file for bankruptcy protection. To increase the likelihood of recovery in the face of bankruptcy or creditor threats any loans to a family business should be properly documented. A recent article in Family Business Magazine outlines a number of elements to increase repayment protection. These include, among other things: properly naming the loan documents, fixing a maturity date and payment schedule, setting an interest rate (and not forgiving interest), securing the loan(s) with assets of the business, use the loaned funds for working capital, and making sure the company is adequately capitalized. In short, to provide added protection from creditors and bankruptcy courts, make a loan based on the same criteria commercial lender would look for, properly document the transaction and honor the terms of the transaction.
