Personal credit cards and loans are often easier to obtain than business financing. The trade is that you assume personal liability for the debt. In addition, the heavier usage can hurt your credit score and scare lenders who think you're running up your cards with consumer purchases. This can, in turn, make it harder to qualify for business credit. Here's what you should do instead:
What’s the Difference Between Personal Debt and Business Debt?
Common personal finance wisdom is that debt is bad. You’re spending money you don’t have plus paying interest until you do get the money to pay it off. Most personal debt is also spent on consuming things such as clothes, electronics, or vacations that don’t provide any financial return. The rare exception is when you need to pay your way to a job interview or buy tools for a job that will increase your income.
Business debt is just like buying things for a new job. It's an investment in your business, and smart investments can grow your business much faster than bootstrapping from nothing. As a general rule, it's smart to take on business debt when the expected return exceeds the interest rate. For example, if you expect a $10,000 loan to result in $1,000 more in profit and $500 in interest, it's probably a good loan to take.
Of course, all investments carry risk, and taking on business debt is no exception. If your business doesn't grow as expected, you'll still need to repay the debt, so you need to make sure your projections are sound and in line with your risk tolerance before you take on debt.
Are You Personally Liable for Business Debt?
If you use your personal credit cards to fund your business, you are always personally liable for the debt. If you use a business credit card or loan, it depends.
Many small business owners will need to sign a personal guarantee for any loans even if they have a corporation or LLC. Once you're more established, taking out debt in your corporate name alone may mean you're not personally liable for it if your business doesn't work out.
What's the Difference in Credit Reporting for Personal Debt and Business Debt?
When you carry high balances on a personal credit card or loan, your credit score will usually go down. This is because using a high amount of your available credit is often a sign of financial distress and possibly not being able to repay that debt. Even if all of your debt is smart business debt, your credit score can't tell the difference between smart business debt and excessive consumer spending if the debt is on your personal cards. In addition, lenders who manually review your credit report also won't see how you spent your money.
Business debt is different in two ways. First, many business credit accounts don't report to the personal credit bureaus or affect your personal credit score. This depends on your lender's policies, so be sure to ask them.
Second, even if business debt is reported on your personal credit report, the account name will show that it's a business product. Lenders who see that account on your credit report will be able to safely assume that the lender who approved the account verified that you have a business and are using the money for business purposes.
The problem with starting with personal debt is that business credit applications usually still look at your personal credit. If your credit score is low because of high business debt on personal credit cards, you may have trouble getting a lower interest business loan.
What Should You Do Instead of Using a Personal Credit Card?
Instead of using a personal credit card, try to establish business credit as early as possible. If you have a business that's already generating cash flows, you can apply for most types of business loans by providing copies of your profit and loss statements.
If you're just getting started and don't have business profits yet, look for a business credit card or loan that asks for a personal guarantee. Many will approve you based on your personal credit and income plus showing proof that you've started a business such as registering your business name with your state.