Finding capital when you are starting a business can be challenging. You may find that your only recourse is to use your own personal credit, and finance the business through your credit cards. Since you can’t get bank loans and other financing, credit cards can be easy to obtain and use to purchase inventory, equipment, supplies, and others. However, it is important to understand that there are risks to starting a business using credit cards, foremost of which is that you are putting your personal credit at risk. Here’s a good article on how you can avoid putting your personal credit at risk when starting a new business.
Most new business owners blindly leverage their personal credit to finance their business. The typical start up small business is capitalized with savings, retirement accounts, friends and family loans and personal guaranteed loans.
This financing strategy creates a number of large risks for the new business owner which drives the enormous number of US business failures that destroy the lives of millions of business owners, and undermines the health of the US economy.
1. You destroy your personal credit score.
By exclusively using your personal credit to finance your new business you put an incredible strain on your FICO credit score by combining personal credit (revolving credit, mortgages, car loans etc.), with the business credit and loans that are also secured by your personal credit. To understand this risk you need to have an understanding of how personal credit score is monitored. Personal credit is not an unlimited credit resource.
In fact, the more you use it the lower your credit score goes. Each time you apply for credit your score has an inquiry, and new business owners often have multiple simultaneous inquiries which are considered a risk by the credit agency and will lower your score. Further, credit agencies have tightened their personal credit guidelines especially as it relates to revolving credit (credit cards). For a business owner who maintains more than a 10% usage on credit cards, your credit score is reduced. When a business owner exceeds 50% usage of a credit card, you will likely not only have a dramatic reduction in credit score, but also, the card provider will likely reduce your available credit limit. In short, you damage your credit score and reduce your credit availability at a time that you need more credit to support personal and business cash needs.
2. Not leveraging personal investments to build business credit.
One of the biggest mistakes a new business owner can make is sinking cash, savings, and investment in the business, and not have this investment reported as a credit line to the business. Every dollar you invest in your business should be reported as a credit line to the business which in turn increases the financial credibility of the business.
The majority of small businesses in the US are depending on access to cash lending to fund the growth and operations of their business. Most business owner do not realize that 95% of all US business credit is in the form of trade credit. The size of this small business trade credit source in the US is greater than one-trillion dollars, however less than 30% of the US businesses utilize trade credit! Building business credit opens an entire new source of trade and cash credit that is not tied to your personal credit score. This means, you have a separate and potentially larger source of credit that will directly support the business cash flow, and will reduce the amount of funding a business needs to start-up and grow.
4. Intermixing personal and business puts your personal assets at risk.
Why did you incorporate your business if you turn around and undermine the security of corporate limitation of liability? When you inter-mix personal and business credit you increase the risk of having your personal assets at risk for lawsuits, and business claims. Every business needs to structure their business to separate business and personal finances, and to maintain such separation for the life of the business. This is the only way to have peace of mind about this.
So how do you avoid destroying your personal credit, and risking the success of your new business? The answer is to following these steps:
- Do not invest personal assets in to the business without having the investment reported.
- Structure your business so it is able to establish and build a business credit file and score immediately.
- Insure that every dollar you spend with vendors and financial institutions is reported to your business credit score.
- Do not use your personal credit score blindly. Only use your personal credit score to establish initial business credit, and as quickly as possible leverage your business credit score to access trade credit and cash that is secured by your business and not by your personal credit.
- Maximize the funding of your business by leveraging vendor & trade credit that will provide improved cash flow and new sources of cash in the business separated from your personal credit and grow the total credit available to your business.
Walter Good is recognized as an innovator, educator, and leader in small business success systems. Mr. Good is a serial entrepreneurial manager who has a proven track record of building successful businesses by leveraging a systems approach of applying success strategies that result in predictable business growth and shareholder value. More at http://www.businessfundability.com
- Pros and Cons of Financing a Business
- How to Avoid Destroying Your Personal Credit While Starting a New Business
- Comparing Loans Before Starting Your Own Business
- How to Use Business Credit Cards to Build Business Credit
- What is the Obsession with Credit Scores?