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Business Debt in a Sole Proprietorship

06.04.2010 by Robert Espe //

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Business debt mixed with our personal finances

DFA Reader Micki asked:

How should we begin to address this financial debt? How do we untangle our personal/business debt and does it even matter since our business is a sole proprietorship? (I have worked outside the business to earn extra money, but my absence cripples the business even more.)

Here is an explanation of their detailed situation:

I have been married for 20 years and have 3 teenage children. My husband, Ron and I own a small wholesale business and have done so for about 15 years. My husband initially started the business, and I took care of bookkeeping. As Ron discussed the venture with his father, Bill, he was encouraged to allow Bill to “help” him; So, because the two had a strong relationship, Ron agreed. Bill took over all finances while Ron was responsible for all sales and customer/vendor relationships and activities. I had entered all invoices and bills into the computer. Bill had never used a computer and refused to do so, therefore, all financial records were kept in his home and all bills and payments sent there as well. My mother-in-law entered all receipts, bills, and taxes. Any time questions arose about the finances, we were assured things were handled and that was Bill’s job. We eventually conceded control. We knew the sales numbers and monthly expenditures and felt confident in our business stability. The business grew quickly and was very profitable. At this point, Bill encouraged Ron to take on a partner who agreed to invest capital in return for a percentage of profits. Trusting his father’s advice, Ron agreed. Terms were agreed upon including a set draw for Bill and commissions for Ron. We spent months developing relationships with vendors that resulted in a preliminary agreement for importation and exclusive rights to inventory. After a short time, Bill realized that Ron’s income was increasing and became dissatisfied with the plan, so, instead of renegotiating the agreement, Bill began paying himself bonuses and selling merchandise to his “friends” under the table and pocketing the money. Our business began losing inventory by the thousands each quarter. The financial partner discovered the inconsistencies and insisted on immediate full return of his investment or face legal action. We paid this from our personal accounts, since Bill insisted there was no other way. Then Ron entered the office one afternoon to hear his father berating our importer for his lack of English skills and culture. He insulted the vendor’s daughter to whom we were personally close and whose wedding my husband had attended and explained that our company had no need of their involvement. The relationship was irreparably severed. Gradually, Ron’s time at the office was increasingly spent arriving late, taking long lunches, napping at his desk, then leaving early. Soon thereafter, I was involved in a severe automobile accident and was unable to work for a couple of months. When I returned, I found things even more unsettling. I overheard my father-in-law on the phone discussing business credit card payments to our vendors, and when I inquired as to the details, I was told it was not my business. Bill was handling the finances. This was the “final straw”. After many years of his promises to retire and leave the company to us, he again gave a date of his departure, and, on that day, we held him to it. He was enraged. He threatened to bankrupt us and said personal things I never imagined a father could say to his son. Upon his leaving he brought bills that we were now responsible for assuring us he would bankrupt our business if we held him responsible for any debt. We were hundreds of thousands in credit card debt. He had apparently forged Ron’s name on some documentation and, on others, had simply claimed full decision-making ability. Ron refused to hold Bill legally responsible or to claim bankruptcy on moral grounds, and we have since been tortured month after month with the magnitude of the debt with which we have been saddled. We continue to pay the bills on time, even those that are in Bill’s name, and his credit has been bolstered as a result. We struggle daily to “rob Peter to pay Paul”. The situation has, over three years time, broken us and nearly our marriage. Initially we were able to begin recovery and advanced repayment of the debts. Then the economy failed. Our business was in the direct line of losses, and customer bankruptcies hit us hard. I am responsible for all finances now, and it is overwhelming. Ron cannot reason with the situation and refuses to talk it through. He did make the decision to use all our available personal credit to shore up the business. We had previously made the decision not to carry any revolving debt. He has cut off all friendships and relationships and looks to me to be his strength. I am at the end. We take full responsibility for our failure to adamantly address the financial questions with his father. We are now paying the price for that mistake. We have forgiven Bill. It remains difficult, however, each month as we see Ron’s parents brandishing new purchases as we struggle to meet minimal obligations and upcoming college expenses. So I guess we are in the process of continual forgiveness.

Business debt, personal finance, and family partnerships

Unfortunately, there is no way to “untangle” your debt from the business. You say it is a sole-proprietorship, although to me it appears to be a partnership, both of which leave the proprietors/partners personally liable for business debt, unless they are incorporated. How to address this debt is more complicated. It is one thing to acknowledge that money is owed, in this case, it will be figuring out what to do about it that will be tricky.

The first thing that strikes me about this situation is how far back the problem goes. You say you have had this business (and these financial problems) for 15 years. Any situation that long in the making will not be fixed quickly. However, decisions must be made and a course set to correct the situation, or you may eventually find yourself in bankruptcy. You say that until recently the two of you did not carry revolving debt, so you know how to handle money, but there may be no realistic way for you to support your business and finance your father-in-laws debts.

Your story is the perfect example of why people should be careful with whom and how they conduct business. Reluctance to confront family members when they do something wrong often makes a bad situation worse. This appears to have been the case here, and I think the first step to dealing with your situation is to be honest with yourself about your father-in-law’s actions. He robbed you and your husband when he paid himself more than was agreed upon and stole the merchandise he sold off the books.

It is one thing to admit that your father-in-law stole from you, quite another to decide what to do about it. I understand your husband’s reluctance to take legal action against his father, however I believe it is misguided. While the Bible does say we are not to take Christian brothers to court, in context that is an injunction against civil disputes. You are dealing with criminal actions, and I see nothing immoral about pursuing legal action in this case, especially if your father will not do right by you after speaking with church leadership about the situation.

I would recommend meeting with an attorney to discuss options. Once you have a good idea of what is open to you, you will be able to decide what you want to do. It sounds to me like your-father-in-law was a full partner in the business, which would make him equally liable for business debt. Even if you pursue no other legal action, at the very least, I would not make any more payments on anything in your father-in-law’s name, what would be the point? If they are his debts, he should pay them, and you gain nothing by paying them for him. Let the collectors come knocking on his door. His threat to bankrupt you if you send him his bills rings hollow.

Finally, I would recommend that the two of you reconnect with your church, other family, and friends. Meet with your pastor to discuss your struggles, especially where you are concerned about legal action against family, and how these business troubles are affecting your marriage. This type of situation is not the kind of thing you two can afford to handle on your own. You need the prayers of others, you need fellowship, and you need counsel. You need to face this challenge as a team, communicate with each other, and make decisions together. Remember that your marriage is more important than the business.

Do You Have Any Other Advice for Micki?

Something you think I missed? Drop a line in the comments below.

Have a question of your own?  Ask DFA writers for free!  🙂

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

Categories // Debt, Earn Money, Money Management Tags // Advice, business, Debt, Finances, personal, relationships

401(k) Contributions With Outstanding Debt

05.21.2010 by Robert Espe //

Have a question of your own?  Ask DFA writers for free!  🙂

Stop 401(k) contributions to speed debt reduction?

DFA Reader James P. asked:

Should I stop 401(k) contributions of $546 a month to pay off the car loan faster??? This will bring my monthly excess for debt payments to $1100. I use the 50/50 plan (50% of excess income goes to pay down debt, 50% is saved).

Matt, I would like to say your blog is one of the first websites I check in the morning for inspiration and knowledge. My family of six embarked on the Dave Ramsey journey in June 2008. Since then, we’ve paid off $47,000. $34k of that was credit card debt (ALL GONE!!!!) My wife and I are 34 and our sons are 14, 13, 10, and 10 so we are very proud of ourselves and the amount we’ve paid off considering the responsibilities we have.

I am currently putting 7% in my 401(k) (receiving a 2.5% match). My wife is currently putting 4% (receiving a 1% match). Our remaining debts include a mortgage, a car loan ($32,000 @ 6.9%) on an ‘08 Toyota Sienna (worth $26,000) and two student loans (totaling $23,000 @ 6%). The Dave Ramsey plan would pay the smallest debt (a student loan) first, but I’m conflicted as to what to do next. My thought is pay off the car next because it is my biggest payment, but I would have to stop my (not my wife’s) 401(k) contributions to make it happen in 1 year. My fear is, if I stop the 401(k) contributions I will miss out on a significant rise in 2010. I will keep the student loans for now because they are tax deductible. Getting the car payment off me would lift an emotional burden but my 401(k) contributions are making me have second thoughts.

Congratulations!

Anyone who has paid off nearly $50,000 in debt in two years deserves a pat on the back. You have been doing a great job, let’s have a look at your situation and see if we can help speed you toward debt free living.

Your Plan or Dave’s Plan?

You want to pay off your car because it carries a higher interest loan, but Dave says you should pay off a student loan, because it is smaller and he wants you to have fewer debts regardless of the numbers. Well, I agree with you. Dave’s debt snowball makes sense for people who lack motivation, have a multitude of smaller debts (3 credit cards, 4 store charge cards, and a couple major appliances) and can benefit from the visible progress of paying off individual debts. However, the amount you paid off this past year shows you are VERY motivated, and down to three big debts. The other reason I agree with you, is that the student loans are unsecured, your education cannot be repossessed, and while the tax deduction isn’t a great reason for keeping the loan around, when combined with the lower interest rate, it isn’t costing anywhere near as much as the car loan. You already owe more on the van than it’s worth, which is not a desirable situation.

A Better Rate of Return

Having established that your plan to pay off your vehicle before the student loans is sound, we will now look at how to do it. A 1-year timetable is a good goal; dragging debts out is never good and the amount is only slightly higher that what you paid off the last two years. You tell us the money you need to pay off your car in one year is currently being contributed to your 401(k). The way to do it then is obvious, your 401(k) contributions must be adjusted, and I am going to address how and why.

You are currently contributing 7% of your salary, and 4% of your wife’s into 401(k)’s although you are only being matched for 3.5% of those contributions. That means you have 7.5% of your salaries that I would consider “extra” contributions. I always recommend that people in debt (including a mortgage) not contribute any more to a retirement plan than is matched by an employer. When contributions are matched, you get a 100% return on investment with zero risk. There is no better investment than that, but for unmatched contributions to net a profit, they must produce returns in excess of what you pay in debt interest. On average, the stock market returns 8% over 30 years. While that is higher than the interest you pay on your debts, ask your self if a volatile investment with a 20-30 year timetable is worth 1%-2%. Paying off your debts offers an immediate guaranteed return of 6%-7% in your case. That is a much better deal.

Planning For an Uncertain Future

You mention your concern that next year may be a good year for the market, and you want to get in on it. Since none of us can know the future and because different “experts” are all just guessing anyway… I would counsel that your investment decisions should be based on where you are financially, not what the markets are doing. Get out of debt, save money, avoid future debt, then invest your surplus.

I would recommend reducing your and your wife’s 401(k) contributions to the amount that will be matched. You will then have the necessary money to pay off your car, then shift your attention to the student loans. Once they are gone, bring your emergency fund up to at least $10,000 if you have not already, and then turn the hoses on the mortgage. Once you are completely debt free, you will have the excess income necessary to max out your 401(k) contributions (as well as a Roth IRA if you are eligible) and your retirement savings can grow steadily without interference from debt.

Do You Have Any Other Advice for James?

Something you think I missed? Drop a line in the comments below.

Have a question of your own?  Ask DFA writers for free!  🙂

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

Categories // Debt, Retirement, Savings Tags // 401k, Advice, auto loan, contributions, Debt, Retirement, Savings, student loan

Car Repairs – Scrap it, Park it, or Fix it?

05.11.2010 by Robert Espe //

Have a question of your own?  Ask DFA writers for free!  🙂

Job loss – prepare by saving or debt reduction?

DFA reader Benedictus asked:

  1. Should I spend another $6,000 to fix a vehicle that is only worth $4,800?
  2. Should we just park the vehicle until we can save enough money to fix it and continue to make $291 monthly car payments and $75 monthly insurance payments until we can save up $6,000 (which would certainly be a year or more)
  3. Should I sell the minivan for parts/needed repair and use that money to buy another older used car with unknown problems and high mileage?
  4. Should I borrow the money to do the repairs, spending more to repair it than the vehicle is even worth, and having to pay both a car note and repair note?
  5. What is the best angle, financially, to deal with this situation?

Car Repairs - Scrap It, Park It, or Fix It?We have a 2006 Dodge Caravan Minivan with 52,000 miles that we purchased new in 2006. It has a 3-year/36,000 mile warranty. We had the van in the repair shop and found out yesterday that the entire engine will have to be replaced at a cost of +/- $6,000. We owe about $5,800 on the vehicle. Trade-in is around $3,200 and private party value is about $4,800. However, neither of those two figures matters because it would have to be repaired first before we sold it or traded it in. WE DO NOT HAVE $6,000 TO REPAIR THE VEHICLE. My husband just recently had to take a second job delivering pizza just to make ends meet and we just started working on re-building an emergency fund after our previous $15,000+ emergency fund was depleted from him being out of work for 5 months before he got the supplemental pizza delivery job. I don’t want to borrow money to fix the car because I would be paying a car note and a repair note. We could almost buy two older used vehicles for what it is going to cost to repair our minivan and I would have to have a vehicle large enough for a family with three children. Then I would be getting an older car with someone else’s problems. Even if we purchased two older vehicles instead of repairing my minivan, then I have a useless 3 1/2 year old vehicle sitting in my driveway. The only solution I could come up with was for us to park the vehicle and be a one-vehicle family until we could save the money to fix it, but I hate to keep making $291 monthly car payments and $75 monthly insurance payments on a vehicle we can’t even drive.

~Thank you, Benedictus

What Makes The Most Financial Sense?

There are many variables here, so naturally you have questions. I will try to answer all of them beginning with your last, “What makes the most sense financially? The answer to this question is usually, “Do not go further into debt.” In fact, owing money on this vehicle is a big part of your dilemma. Adding more debt will only compound the problem. Therefore, I would say the one thing you absolutely should not do is borrow money for the repairs (this is Debt Free Adventure after all.)  With that option off the table, we will look at the pro’s and con’s of the other possibilities you listed.

Scrap It?

In situations like this, we tend to feel let down by the vehicle we have. This makes us want to junk what we have, and try for anything different. Caution is warranted, as disappointing as it is, solid vehicles break down sometimes, and recklessly jumping to another vehicle may not alleviate the problem. As you noted, few people sell perfectly good cars, so anything we buy will have problems of their own. That being said, if you have to have another vehicle now, a used car that you can afford may be the only option.

Park It?

Unfortunately, the payments will have to be made no matter what you decide. Since you owe more than the vehicle is worth in its present condition, whether you scrap it, park it, or fix it, you will have to keep paying on the car note. More unfortunately, it is likely that you will have to maintain full insurance coverage as a condition of the car loan even if you park the vehicle. Check your loan documentation to find out for sure. If the option is available, you could save money by parking the van, and only maintaining the comprehensive coverage.

Fix It?

You may not have the money now, but once you save up the money, this is still a good option. While the vehicle may not be “worth” that much, that is not an important consideration. Vehicles are an expense, not an investment. We spend money on vehicles for transportation, and eventually they end up being worth $0. What that means is you are asking the wrong question. The question is not whether it is worth $6,000 to fix your van, it is whether $6,000 would buy a better vehicle. The answer depends upon your local used car market, but consider that because you bought this van new, you know if it has been maintained. That is worth something and should be factored into your calculation. If a better vehicle is available, buy it, if not, fix the one you have. Finally, before you make a decision on this point, I would get a second estimate on the engine. $6,000 sounds a little steep to replace the engine in a domestic vehicle; I would have expected it to be closer to $4,000.

In Summary – What is the best way to deal with this situation?

  1. Should I borrow the money to do the repairs? No.
  2. Should we continue to make payments while we save? Yes, the payments must be made no matter what you decide as the van is worth less than you owe.
  3. Should I spend $6,000 to fix a vehicle that is only worth $4,800? Yes, if a better vehicle cannot be bought for the same amount.
  4. Should I sell the minivan? No, better to still have the van after making payments, than to sell it and make payments on nothing.

I think you were on the right track before you wrote to us. If I were in your situation, I would live for a time as a one-car family. Your financial situation makes this necessary. While it is no fun paying for a broken car, a contract is a contract. Learn from the experience; buy your next car in cash. Save your money for the repair; next year you will be a two-car family again; your low-mileage van will have a brand-new engine, and you will be one step closer to being debt-free.

Do you have any other advice for Benedictus?

Have something to add?  Please share your wisdom and experience and help point Benedictus in the right direction.  Thanks!

Have a question of your own?  Ask DFA writers for free!  🙂

*Disclaimer*
We accept no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Any advice taken from this site does not in any way establish a client/adviser relationship.  We always recommend that you consult with a licensed, qualified professional before making any financial or investment decisions.

Categories // Debt, Savings Tags // Advice, automobile

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