For every year since the early 1960’s, the United States has highlighted a week in the spring to recognize America’s small business owners and entrepreneurs. According to U.S. Small Business Association statistics, over 50% of Americans either own a small business or are employed by one – and small businesses are responsible for creating the lion’s share of new jobs throughout the country.
Unless you’re among the fortunate few who already have access to deep capital reserves, you’re probably going to require access to credit for your small business at some point. A line of credit – whether via a small business loan, a business credit card or another source – allows you to grow your business, cover unexpected costs and even take calculated risks in search of new financial advantages, but it may also come with serious risks.
In particular, improper use of business credit has the potential to affect your personal credit as well as that of your business – with potentially disastrous results. How can you limit your risk and exposure without sacrificing access to the credit your business needs to thrive?
Structure Your Business Properly
If you’re currently a sole proprietor, your personal finances and those of your business are essentially one in the same. This is a big problem if you intend to use business credit. To address this issue, consider restructuring your business. Establishing your business as an LLC, C Corp or S Corp will clearly separate your personal and business finances, offering a multitude of protections in the event that your business encounters legal or financial difficulties. Keep in mind, however, that it’s important to consult with a legal professional to determine the appropriate structure for your business.
Stay Within Your Means
Whether it’s acquiring new equipment, expanding to an emerging market or anything in between, there are many reasons you might wish to apply for a line of credit for your business. However, this isn’t always the best choice. To limit your risk and curtail potential problems down the road, carefully consider whether applying for and using credit is the right decision. It’s rarely useful to extend your business obligations beyond what you can realistically expect to pay, and it may be better to put off that large new expense until you’re in a more advantageous financial situation.
Build Strong Business Credit
Just as a good credit score is important to your personal finances, a strong credit history is essential for any healthy business. An established track record may grant you access to greater lines of credit, lower interest rates and more favorable loan terms, all of which are tremendously valuable when it comes to managing debt and protecting both your business and personal credit. Establishing a separate business entity is essential for this purpose, as are registering a federal Employer Identification Number and opening a bank account for the business. Once these things have been done, you can build credit quickly by taking out manageable business loans, paying off balances in full whenever possible and consistently making monthly payments on time and above the minimum amount.
Consider a Business Credit Card
A business credit card is very much a double-edged sword. It offers a convenient, revolving line of credit that can be used to cover all sorts of expenses, it’s a great tool for building credit quickly, it’s often much easier to get than a bank loan and many business cards come with great rewards and other perks. However, a business card also comes with considerably higher interest rates, significant penalties for late or missed payments and greater risk of accidentally overspending. Even worse, most business credit cards require a personal liability agreement, meaning that any problematic activity will be reflected in your personal credit score as well. To minimize these issues, consider seeking out a business card that does not routinely report to consumer credit reporting agencies.
Explore Alternative Financing
Even if your business is in need of financing, that doesn’t necessarily mean you have to open a credit card account or apply for a small business loan. Instead, explore alternative ways you may be able to finance your venture. For fledgling businesses with significant capital needs, taking on a partner or working with an angel investor may be the most sensible solution. For smaller costs, borrowing money from friends or family may be the best route. Other loans, such as borrowing against a 401(k) or other retirement plans, may also allow you to cover expenses without imperiling your personal credit score. There are many options available, so it’s best to consult with a financial professional to determine the best course of action to meet your specific needs.
If you do need a small business loan, a bank loan usually has the best rates — but they’re hardest to come by. If your bank says no, look to SBA 7a lenders or credit unions — and from there search for your local CDFI, like Pacific Community Ventures, instead of going online where you might find predatory online lenders.
Nearly any small business will require access to credit at some point in time. Of course, that doesn’t mean you need to put your personal credit standing on the line for the sake of your business. By following the tips above and practicing responsible financial habits, you can continue to grow your business without exposing yourself to unnecessary risk.
Beth Kotz is a contributing writer to Credit.com. She specializes in covering financial advice for female entrepreneurs, college students and recent graduates. She earned a BA in Communications and Media from DePaul University in Chicago, Illinois, where she continues to live and work.