One of the most pressing and important issues for small businesses is the management of cash flow. Often, revenues are either insufficient or too irregular to cover business expenses from month to month. In order to prevent these shortfalls from damaging the company, owners often use personal funds to loan money to the company in order to cover expenses. While such loans from the sole owner of an LLC to the company are permissible, they must be handled appropriately.
Separate Entity and Legal Liability
In general, the purpose of forming a limited liability company is to create a legal separation between the assets of the company and the personal assets of the owner. This means that if the company has a debt or a judgment against it, the so-called “corporate veil” can shield the owner’s house, car and personal monies from the company’s creditors. Where there is only one owner, there is a risk that the company will be seen as a sham and a court can pierce the veil and access the owner’s personal assets. In order to receive the legal protection of limited liability, the owner must treat the company as a separate entity, not as a personal bank account.
In order to preserve limited liability, a loan from a member to an LLC must be in the business interests of the company and must be at a reasonable rate of interest. This means that the company must have an actual business need for the money and that the rate of interest at which it pays it back must be within market rates. In addition, there must be a set term for the loan and a payment schedule set and adhered to.
Any loan from a member to the LLC must also be documented by a promissory note that evidences the principal amount of the loan and its term and interest. The note must be signed by an officer of the company. If the single member LLC has only one employee, then the owner must sign in his or her capacity as an officer. The loan must then be entered into the company books and characterized as a loan from a member.
When a member makes a loan to an LLC, he becomes a creditor of the company and must be repaid along with other creditors of the company. A loaning member should not choose to repay their own loan in preference to other debts of the company, as this may give rise to an allegation of self-dealing, which would negate the shield of limited liability. The same applies in a bankruptcy proceeding, where an excess of loans from a member may be characterized as an attempt by the member to place their ownership interest at the same level as a lender, which a court may invalidate.
Kevin Doran has been a writer and editor since 2009 whose work has been published in the "Southwestern Journal of International Law." He received a BA in Classics from USC and a JD from Southwestern Law School and is currently pursuing an MA in History at Western New Mexico University.