How Does An LLC Borrow Money?

There are several ways an LLC can borrow money to fund its operations.

Most people would immediately turn to a bank as their lender of first resort, and there may well be some sense in that.

But banks are by no means an entirely straightforward prospect for an LLC, because banks are innately cautious, and like all other lenders, they understand that the nature of an LLC is to limit its members’ personal liability. 

That means they can require specific promises and agreements before lending to an LLC, and it might also mean they only lend for specific types of funds. Meanwhile, other sources of potential funding are available when an LLC needs to borrow money.

Credit unions and even private individuals (especially existing members of the LLC) are alternative sources of funding that can help an LLC overcome any cash flow bumps in the road.

How Does An LLC Borrow Money

Above all, it’s worth doing your research before simply choosing a lender.

In fact, do it preemptively, in case you ever need to borrow money, so you can act with a swiftness that’s appropriate to the business, without making rash decisions and choosing a lender that could potentially complicate or compromise your position when it comes to future liability.

Let’s take a quick look at the options available.

Private individuals and LLC members

LLCs provide personal liability protection to their owners and members, which makes it look as though getting private ‘third-party’ loans from LLC members might be the best first step when an LLC is seeking additional finance.

It’s worth remembering though that because LLC members can’t be personally liable for the LLC’s, lenders will need a personal guarantee when lending to an LLC. You also have to make sure the loan is reasonable, or the IRS may claim it’s an additional capital contribution.

If an LLC member advances money to the LLC, it can be in the form either of a capital contribution or a loan. That’s a distinction with significant tax consequences – hence the potential interest from the IRS.

A capital contribution could increase the member's ‘stake’ in the LLC interest on a dollar-for-dollar basis, but a loan only increases the member's status by an amount equal to his or her increased share of LLC liabilities.

If a member’s advance of funds to an LLC is ruled a bona fide debt, it can be treated in the same way as any other third-party loan.

That means payments of both the principal and the interest will be taxed as if the loan were between unrelated parties. The lending member will report interest income in their own personal tax return, and the LLC will account for the interest paid to the member in its accounts.

To ensure the loan is treated as a third-party debt, there needs to be a promissory note drawn up, just as there would be if the LLC borrowed from any non-member private individual. That note would need to include a fixed payment date and provide for reasonable interest to be paid.

When an LLC borrows from one or more of its members, it also helps to be able to show that the member has a right to seek a security interest in any LLC property, and that it’s written in such a way as to reflect commercial definitions of ‘reasonableness,’ — a waiver of demand, presentation, and notice; the right to an attorney's fees; and guarantees from other members of the LLC, etc.

A Credit Union

Borrowing from a credit union as an LLC is in some ways simpler than going direct to the bank, and in some ways a little more complicated.

First, you have to find a credit union that works on a scale big enough to help your business as and when you might need it.

Credit unions, unlike banks, are limited in the amount of money they can loan to individual members, and while they’re an option for many small and medium enterprises (SMEs), it could well be tricky to find one that can offer you loans big enough to help your LLC in a time of need.

Most credit unions – again, unlike many banks – are restricted in terms of the circumference of the aid they can give. They exist more or less to help local people and local businesses, so if you’re in Ohio, all the net searching in the world will cut no ice with a credit union in Florida.

If you find a local credit union that you think might be useful at some point, join it, and establish a good relationship with it for some time before you hit it up for a loan.

Where banks are relatively unrestrained in their ability to ‘loan on a first date,’ credit unions tend to be more receptive to loaning to longer-established members. 

They’re more likely to do this because credit unions are owned by their members, meaning decisions tend to be made on a local, practically personal basis, so being a friend and a supporter to the credit union for some time before you ask to take from its money pot is likely to get you more success when you need that extra funding.

It’s worth remembering of course that as an LLC, you can be a member of a credit union as well as having a relationship with a commercial bank.

Bank Loans

Yes, as an LLC, you can borrow money from a bank to fund the business, however, there are a few things to know before putting in your application.

The point is that an LLC as an entity exists almost solely to protect its members’ personal liability.

So, from a bank’s point of view, it can only view the LLC as an entity composed of its corporate assets, rather than an entity composed of its corporate assets and potentially the collateral assets of its individual members.

That will make banks less likely to lend to LLCs unless the LLC has a significant asset-bank as a corporate entity that it can use as collateral for any loan it wants to take out.

If the LLC does not have such an asset-bank to use as collateral, the bank will likely find itself at an impasse – unable to tap into individual members’ assets as collateral for the corporate entity that is the LLC (and the potential borrower), it will find itself between a rock and a poor place.

In such circumstances, it is likely that a responsible bank will severely restrict the amount it can lend to an LLC, in line with the real assets owned by the company that are available to be used as collateral.

Alternatively, it could try and break the lending stalemate by requiring more than the LLC’s signature on any loan agreement.

If individual members of the LLC sign their name to any loan agreement, then they will be seen as no longer covered by the liability shield around their personal assets – at least as far as the amount being borrowed is concerned.

Therefore, when LLCs are looking to borrow from banks, there is a cost/benefit analysis question to be answered. How vital are the funds being borrowed? Will the LLC no longer function without the loan? In which case, what sort of time limits are imposed on the loan and its repayment?

Is there enough to be gained from some members – or potentially, depending on the size of the loan, all members – stepping out from behind their liability shield to act as guarantors of the loan from the bank?

Would it be more cost effective to simply make individual third-party loans to the LLC, while keeping the overall liability protection in place?

That would mean each member who volunteered would be personally risking their present capital to maintain the LLC or allow it to expand in ways that would become profitable. 

But at the same time, it would not necessarily leave them liable for interest accruing, because the bank would not be involved, and so the interest would not be accruing on any loan.

The reality then is that while mainstream banks will lend to LLCs, the price of them doing so might well be either the signing over of various assets to the company which can be used as the LLC’s own bank of collateral, or the selective forfeiture of the liability protections that the LLC was created to provide for its members.

Which is why, if at all possible, finding alternative ways to borrow money would often be preferable both for an LLC and for its members.