There are times when many business owners might be tempted to use a personal loan to pay for business expenses. For example, when a business is still in the idea stage, or otherwise very young (under a year old), it can be difficult to access financing via a traditional small business loan, which is why many business owners are tempted to use their personal credit. Nevertheless, startups aren’t the only businesses that consider using their personal credit for business. In fact, I recently read an article suggesting this course of action in some situations. I have reservations with this approach, however.
Many small business owners leverage their personal credit in the early years of starting a business, but as quickly as is possible, it’s better for a business to start building business credit.
There are a few very compelling reasons why I feel this way. First, using personal credit doesn’t do anything to build your business credit profile, which will be an important factor down the road—making it even more difficult to acquire financing when you might need it.
It Doesn’t Help Build Your Business Credit
Building a strong business credit foundation should be a priority during the first few years in business. In the beginning, most businesses have a fairly thin business credit profile. In other words, because they probably don’t have many business credit accounts, there’s nothing the credit bureaus or your creditors can view to see how you’ve handled business credit in the past, which makes it a challenge to predict what you will do in the future.
Although this can feel like a catch 22—you need to have business credit to demonstrate you can be responsible with business credit, but you can’t get business credit because you don’t have a track record that demonstrates you can be responsible with business credit. A challenge? Yes. But there are some things you can do.
“While their credit scores will naturally be lower because their credit history is short, there are often other factors that make these business owners potentially good borrowers,” said Peter Bolin, Director of Consulting and Analytics for Experian, in an interview we published last year on BusinessLoans.com. “We are telling our lender customers to avoid automatically dismissing this group as high risk. In our study group, an average Experian business credit score of 23 (on a scale of 1-100) the first year of business, soon improves to somewhere in the 30s, and eventually has moved into the 40s.”
This improvement doesn’t just happen though. One of the things successful small business owners are doing to build a strong business credit profile is pursuing trade credit relationships with their suppliers. “It’s not likely you’ll be able to go into the bank and get $100,000 for working capital,” said Bolin. “Start by establishing trade credit with your vendors. Make sure they report to the credit bureaus, like Experian, and make sure you make your payments on time. Apply for a business credit card and make sure you make those payments on time. This will dramatically increase the depth of your credit report so when you do need that $100,000 from the bank or other lender, you’ll be likely to get approved.”
It might not be the capital you would like to get your business off the ground, but practices that help you build a strong credit foundation might be more important in the long run—depending upon the nature of your business and your objectives.
It Doesn’t Help Your Personal Credit Score
For many small business owners, the need to build and maintain a good personal credit score will likely never go away. With that in mind, using your personal credit for business expenses might not be the right choice.
A big part of your personal credit score is based upon how much credit you have available verses how much credit you actually use. Maxing out a credit card, for example, could negatively impact your personal credit score. It’s not uncommon for the higher balances often associated with business expenses to pull down your personal score because they impact the ratio of credit available to credit used. This may be true even if you regularly make the required payment every month.
When I recently asked if using personal credit for business might hurt a borrower’s personal credit score, Bolin’s response was, “Yes it does. Their higher utilization of personal credit to the credit available to them pulls down their personal scores.”
He continued, “Once you open the doors, start looking for places where you can establish business credit accounts rather than relying on your personal credit.”
In other words, instead of using your personal credit, take the time to establish a strong business credit profile. Consider it an investment in the future of your business.
In addition to establishing trade relationships with your vendors, a business credit card could be a good option for very young businesses trying to establish a stronger business credit profile. Although the initial balances will likely be smaller, they can give you the opportunity to demonstrate you can responsibly use credit—improving your profile.
Additionally, as you establish credit relationships with your suppliers, make sure you ask whether or not they report your credit behavior to the appropriate business credit bureaus. If they don’t, your good credit practices may be building a good credit record with that particular vendor, but you’re not doing anything to build you business credit generally. This is important enough to encourage those suppliers who don’t report to do so.
Personal Credit and Personal Loans
In the real world many entrepreneurs dip into their home equity, use their personal credit cards, or other personal credit to get their businesses off the ground. It can be expedient and the credit is available. I have to admit; I’ve even dipped into home equity to do the same thing. Nevertheless, the longer you rely on your personal credit the longer it will take you to establish a strong business credit profile and the more problematic it can become to qualify for a small business loan.