So You Want to Start a Business. How Much Does Your Personal Credit Score Matter?David Cawthon
Here’s the harsh truth: Few are lucky enough to own a business that generates enough cash to provide its own capital. That capital often must be raised from funding and financing sources outside the business—and for most small businesses, that means a loan.
There can be consequences if you default on that loan: It might ding your personal credit score, your collateral might be at risk of foreclosure and it will affect your ability to get a personal loan.
Aren’t there other ways to raise funds?
Sure, there are quite a few ways to raise funds, and small-business owners sometimes have to get creative because finding enough cash to feed a growing business can be tough: That goes for startups and established businesses.
Seeking funds from investors might seem like a good idea, but there are a whole host of considerations that might not make this a great option for your business. Plus, most investors want to cash out their winnings within three to five years. If they don’t see a clear path to exit with a large payout, investors will pass on the opportunity.
And so, credit is typically the only option available to small-business owners needing capital. Banks can provide that needed capital, but only if you can provide assurances and examples that show they will be paid back.
Before you start talking about credit, you have to get in the door. So how do you start that conversation with a banker?
Why does my personal credit matter?
You might’ve heard of the 5 Cs of credit. One of those Cs–character–relates to “credit character,” or how responsibly debt and other obligations are honored. This includes no bounced checks, no late payments and no defaults on loans. Your credit score is the primary way of determining credit character.
When evaluating credit scores, which score matters? To ensure repayment, lenders will require a personal guarantee of repayment from the owner, not the business. Because it is the owner’s guarantee that’s required, the business owner’s credit score is what matters.
Most small businesses never outgrow the shadow of their owners when it comes to credit score, says Vince Haworth of Bank Midwest.
“I have heard and seen this debated over and over, where key credit decision makers say that if the owner cannot manage their own credit, then it’s unlikely they can manage the business’s credit,” he says.
If a company has more than one owner, anyone who owns more than 20 percent of the business will have to provide a personal guarantee. If you have a business partner who’s reckless with personal finances, he or she may become a liability when you want a loan for the business.
Can’t I just walk away from business debt?
If you walk away from your business, any outstanding debt will still be your responsibility. If you don’t pay your debts, your personal credit rating will likely take a beating. (Remember, you signed a personal guarantee.) This will not only affect your ability to get a business loan, but it will also affect your ability to obtain personal credit. In addition, your collateral will be at risk of foreclosure. Some nasty consequences.
Smart business owners will always be able to access capital when needed. When it comes to credit, they cultivate their credit character by maintaining an excellent credit score. Failure to have a good credit history could close the door on this option or make a desperate owner to take on high interest-rate loans because they don’t qualify for a traditional loan with low interest rates.
Want to learn more about credit, business finances and other vital parts of starting your own business? Super busy and don’t have a ton of time? Perfect. The Kansas Small Business Development Center at Johnson County Community College has just the course that covers all those business essentials in a workday. Check out Business Basics in a Day and other classes they offer.