Considerations for Owners Lending Money to Their Company: Obtaining Security (Collateral)
Jeff Storch | 02.06.20
Often, owners of a business lend money to their company, whether for short-term needs or for longer-term purposes. Too often, owners may not take the time to document the loan or take other steps to protect the owner as lender.
This is the third of three posts discussing steps owners can take to protect themselves: discussing whether and how to obtain security (collateral) for a loan to the company.
If you loan money to your company, in addition to documenting it by a promissory note (see prior article) and charging minimum interest (see prior article), you also should consider whether you wish to take some type of security in the company’s assets. This generally would require some sort of security agreement and some step to “perfect” the security interest. (A detailed discussion of perfection is beyond the scope of this post, but it is crucial to perfect a security interest.)
By having a perfected security interest in the company’s assets, you as lender would be in line to get repaid before any unsecured creditors (e.g., suppliers who do not have a security agreement from the company) or secured creditors who perfected their security interest after you (these would be “junior creditors” to you). However, you would be behind any “senior creditors,” creditors who perfected their security interest in the company’s assets before you. Further, if the company later attempts to get a new loan, the lender might require you personally to subordinate your interest to theirs (i.e., allowing them to become senior to your interest).
While we generally recommend lenders get what security interests they can from a borrower, if the costs are high relative to the potential benefit of the security interest, it can be a reasonable business decision not to obtain and perfect a security interest. Reasons you might decide not to obtain and perfect a security interest in a loan to your company include:
- If all or substantially all the company’s assets are pledged to creditors senior to you, then if the company must be liquidated, there may not be anything left for you.
- If you anticipate the company obtaining additional loans from third party lenders, you can expect them to require you as owner to subordinate your interest to theirs. There will be some transactional costs in subordinating your interest.
This concludes our three-part discussion of considerations for owners lending money to their company.
DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.