As Denver business lawyers, we routinely deal with entrepreneurs who combine their personal and corporate finances in what’s known as comingling funds. Unfortunately, this can have dire repercussions for the owner and the company. For starters, it may also lead to misunderstandings and disagreements between the owner and the company.
But that’s just the beginning of the problems this can cause.
The Dangers & Difficulties of Comingling Funds
Let’s discuss the dangers and difficulties connected with mixing personal and business finances to help you avoid the challenges it poses.
Risks of Comingling Funds
While it may seem convenient to manage finances, comingling funds can have serious consequences for business owners.
A few examples include:
- Legal problems
- Financial difficulties
- Damage to the business’s reputation
Business owners should avoid comingling of funds and maintain separate personal and business accounts to protect themselves and their businesses.
The alter ego doctrine
One of the leading legal issues with comingling funds is the concept of alter ego. In business law, the alter ego doctrine holds that a business owner can be held personally liable for the debts and obligations of the business if it can be shown the owner treated the business as their personal property and disregarded the separate legal identity of the business.
Let’s review an example of what this can look like in practice.
Suppose a business owner comingles funds and mixes personal and business expenses. In that case, it can be seen as evidence of an alter ego relationship and may lead to the owner being held personally liable for the business’s debts.
For example, what if a business owner uses business funds to pay for personal expenses or uses a business credit card for personal purchases?
This can indicate the owner is treating the business as personal property, not as a separate legal entity. The result? Legal problems if the business incurs debts or is sued, as the owner may be held personally liable for the debts or obligations of the business.
Piercing the corporate veil
Another legal issue with comingling funds is the concept of piercing the corporate veil. The corporate veil refers to the legal separation between the business and its owners in business law. This separation protects the owners from personal liability for the debts and obligations of the company.
The business’s debts can personally hold the owners liable. However, if someone “pierces” the corporate veil, they have disregarded the legal separation between the company and its owners.
Mixing funds can indicate no separation between the business and its owners, potentially leading to the piercing of the corporate veil.
For example, when a business owner comingles funds and mixes personal and business expenses, it shows the owner doesn’t treat the business as a separate legal entity and doesn’t maintain the necessary separation between personal and business finances. This action pierces the corporate veil. Then, the owner can become personally liable for the business’s debts and obligations.
Comingling Funds: Practical Problems Worth Noting
In addition to legal issues, comingling funds can also lead to practical problems for business owners.
1. Tracking and managing business expenses
Tracking and managing business expenses and income can be challenging when mixed with personal finances. In turn, making informed business decisions and accurately reporting financial information becomes more difficult. This can be particularly problematic for businesses that must maintain accurate financial records for tax or regulatory purposes. After all, comingling funds makes it harder to comply with these requirements.
2. Confusion and misunderstandings
Comingling of funds can also create confusion and misunderstandings between business owners, making resolving disputes or financial issues trickier.
Assume two business partners comingle funds and mix personal and business expenses. In that case, it can be challenging to determine who is responsible for paying which costs or how to divide profits or losses. This can result in conflicts and misunderstandings between the partners, making it harder to manage the business effectively.
3. Legal issues and financial difficulties
Business owners should avoid comingling funds and maintain separate personal and business accounts to protect themselves from legal issues and financial difficulties. If they keep personal and business finances separate, business owners can better manage their finances, avoid legal problems, and protect their company’s reputation.
Don’t miss this post next: Founders’ Agreement: Essential For the Success of Your Business.
The Doe v. XYZ Company is one instance of mixing business finances and the resulting legal ramifications. In this instance, the proprietor of the small retail company XYZ Company frequently used company money to pay for personal needs like groceries and energy bills. This made it challenging for the owner to precisely track business spending and revenue, resulting in financial issues for the business.
When the company ran into financial problems, its creditors started taking legal action against it. However, it wasn’t easy to discern between personal and commercial assets because the owner had mixed up the money.
Because of this, the creditors contended the business was just an extension of the owner’s finances and the owner was responsible for the company’s debts on a personal level.
The adverse effects of comingling funds compelled the owner to file for bankruptcy, forcing the company to shut down. Ultimately, the judge sided with the creditors and declared the owner personally responsible for the company’s debts. This implied the owner’s funds and other assets, including their house, were subject to seizure to pay off the company’s debts.
Conclusion: Why Business Owners Should Avoid Comingling Funds
Comingling finances puts business owners at risk of losing the legal safeguards their corporate structure provides and could make them personally accountable for business debts and obligations. Business owners must manage their money carefully and separate personal and business funds to protect the company and the owner’s assets.
Speaking of risks, don’t miss this article next: 6 Business Risks & Mitigation Strategies Every Business Needs to Plan For.
Unsurprisingly, we don’t recommend business owners even comingling funds. Instead, if they keep personal and business finances separate, business owners can:
- Protect the legal status of their business
- Maintain accurate financial records
- Ensure the long-term financial success of their business
Contact the team at Contiguglia Law to learn more about our Denver business law services and the best ways to safeguard your business.
Don’t forget: My book “Don’t Skip the Legal: The Startup Guide for Entrepreneurs and Business Owners” covers effectively separating business and personal funds and other vital legal considerations in much greater detail. It’s available on Amazon—buy your copy today!
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