As a founder starting a new business, you must be careful to prevent your business loan and your personal credit from being tied like two planes to a fueling umbilical cord.
Personal Guarantee on a Business Loan
Depending on how you structure your startup and the type of business credit you are pursuing, a lender may ask for a personal guarantee or, essentially, collateral. Think of a personal guarantee as having “skin in the game” where there is a legal promise to personally repay the credit issues if the business can’t make payment. A personal guarantee ties your personal credit to the business loan and ensures that you, as a founder, are “on the hook” for the loan if the business folds.
Some founders in early-stage startups don’t qualify for a business loan and use a personal loan with a home equity loan to fund their business. Essentially, their home is the personal guarantee or collateral for the loan.
Use Business Credit Cards
An entrepreneur must build their business credit much like an individual builds their personal credit by paying bills and credit cards on time.
A founder can apply for a business credit card to manage cash flow and increase working capital. Business credit cards for, say, fuel or office supplies are not too difficult to obtain. An entrepreneur could use these cards to fuel the company vehicle(s) and buying supplies, offsetting these expenses to other areas of the business. Paying these business cards on time will build the startup’s business credit.
You need to research business credit cards thoroughly to see if they require a personal guarantee. If so, late payment or non-payment can affect your personal credit.
How to Remove the Tether
As discussed, a startup often faces a link between their personal credit and business loan like two planes refueling.
Here are some suggestions to keep business debts off personal credit reports:
- Choose the proper structure for your business. An LLC (Limited Liability Corporation), S Corp or C Corp can separate business finance from personal. Lower cost legal resources like LegalZoom can help you structure your business without paying an expensive business lawyer.
- Choose a business credit card that doesn’t regularly report activity to consumer credit reporting agencies like Equifax or Experian. Keep in mind, if you are late or skip payments, however, your personal credit will be impacted.
- Choose an alternative to a home equity loan or personal credit card as a source of working capital. For example, you can use a loan against retirement plan like a 401(k) to fund your startup that won’t show up on a consumer credit report.
Personal Debt Is a Factor
A poor personal credit score or extensive personal debt incurred by, say, student loans can adversely affect your ability to pursue a business loan. When launching a startup, you will want to build your business score as reported by the three major business credit bureaus (Dun & Bradstreet, Equifax and Experian) much like you build your personal credit. A lender is not as interested in your “score” as the historical ability of your business to demonstrate revenue to repay the loan.
If you don’t qualify for a business loan, you may need to pursue working capital with options based on your personal credit score like a credit card or home equity line of credit.
The best strategy for business funding is to keep the planes separate — your personal credit removed from your business loan. Research options like a favorable business structure or establishing business credit without a personal guarantee.
If you are a startup or looking to grow your business and seek additional advice on how to separate a business loan from your personal credit, tap here for a free consultation.