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Loan Versus Equity in a Company

Most businesses are funded by money or “sweat equity” contributed by the owners in exchange for stock (in a corporation) or membership interests (in an LLC). That’s ok, particularly for the initial funding of the company, but you need to understand that if the company goes down, the stockholders and members are the last people to get anything out of the failing company.
Why not put yourself on top of the list for getting paid back? Nobody ever thinks their little company will fail, but the facts are that the majority of small businesses fail within the first five years. Success is sweet when you know how to structure and fund your new business venture. And if there is a bitter failure, it will still taste a lot better going down when you are prepared.
That can be done by funding the company with personal loans rather than equity buy-ins. My YouTube video explains how this is done:

 

If your operating agreement or bylaws don’t specifically address the company dissolution process, you will have to follow your state’s rules. This is one case where it is really nice to have written your own rules. Usually dissolution requires a unanimous vote and/or written agreement accepted by all the owners. Whether you choose to dissolve your company based on rules in your company documentation, unanimous vote, or unanimous written agreement, make sure you have a written record of the decision and how it was made. Put the written record safely in your company records. Once the official decision has been made to dissolve the company, you’ll need to settle debts with all known creditors and send notice to all your known clients and creditors that you’re going out of business. After all the debts and taxes are taken care of, you will distribute any remaining assets to the company owners.

Note that if you have loaned your company money, that money will have priority over any distributions to the owners. When you are putting money into a company, it may be better to put the money in as a loan rather than an equity (stock) purchase. In the end, the loan will get paid back before the owners get anything. Generally, when you are distributing assets upon dissolution, employees are first, debtors are second, and owners are always last. It is also particularly important to pay any outstanding taxes the company may owe. The IRS will always come back against the company principals personally for the company taxes, so they should be high on the list of debtors to be paid.

You should also remember that in order for this loan to be recognized as valid in the list of debtors, it needs to be a real loan, with all the proper paperwork and reasonable interest due on the debt and terms for repayment spelled out in full. (Bonus: this repayment and interest is a good way for you to be able to get money out of your company legally without having to pay the extra social taxes that come with paying yourself a wage to get money out.)

Treat the company as a separate entity from you and you will get the protection you need. Treat it as an extension of yourself and the courts will consider it to be such. Make sure you follow all the formalities and you will be in good shape in maintaining your corporate shield.

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