Use “Other People’s Money” The Right Way
Ask an entrepreneur about how he or she got started, and you will likely hear stories about long hours, bulldog persistence in the face of great odds – and credit cards and home equity lines maxed to the limit. While a few start-ups are lucky enough to either grow debt-free or receive lots of investment capital, most small businesses will borrow. And many times they will rely initially on founder’s credit cards or personal credit.
In theory, using “other people’s money” isn’t a bad idea, but in reality there are mistakes you will want to avoid if you use this strategy. Start off on the right foot and build a business credit rating as soon as possible. Otherwise, even an established business may find it impossible to get credit in the businesses name and avoid personal guarantees.
1. Get Business Credit, Not Personal Credit
Even if you must provide a personal guarantee, business credit can be preferable to using your personal credit. Many business credit cards and loans are not reported on your personal credit report, and this means your credit rating will not be affected by the amount of debt you are carrying to finance your venture. Keeping your business and personal credit separate can also help you avoid missing out on valuable tax deductions.
2. Don’t Let Credit Ratings Get Personal
Business credit ratings are very different personal credit ratings in some key ways. For the most part they are also completely separate, though there are business credit scores based on both the risk of the business and the personal credit of the owner of the company.
Business credit ratings are not covered by credit reporting laws the way personal credit ratings are. Mistakes can be difficult to correct, so it is essential to establish business credit correctly the first time.
3. Set up a Proper Corporate Structure
Before you try to begin, set up the proper corporate structure. There are plenty of reasons to avoid doing business as a sole proprietor, and the ability to establish a corporate credit profile as a separate entity is another one.
4. Get Listed
Once you’ve formed your corporate structure, the first step is not to apply for a loan! In fact, before you start filling out applications, you will want to take basic steps to ensure your business appears stable to the reporting agencies. That means getting the proper occupational licenses, and a phone number that is listed with directory assistance in the business’s name, among other things.
5. Create a Paper Trail
Once you have established your company as a legitimate enterprise, you will need to buy products and services from companies that will report your payment history to the major business credit reporting agencies such as Dunn & Bradstreet and/or Experian. While personal credit ratings depend largely on how you handle your payments on credit cards and other types of loans, business credit ratings can be built with “trade” credit (vendors who extend products or services on payment terms). Other factors such as the industry your business is in, and even the state of your local economy, can factor into some of the business credit ratings.
6. Read Loan Fine Print
When you do borrow, make sure you pay attention to the cost of your loans. If you are using business credit cards, for example, pay close attention to your interest rate. Credit card rates have been inching up, and the “default rates” lenders charge if you miss a payment or have a lot of outstanding debt, have skyrocketed. I have seen credit card rates go as high as 29.99%, even for consumers who have never missed a payment!
7. Use Business Credit Cards – Responsibly
Business credit cards can be a great tool, but be careful about amassing large amounts of credit card debt, especially on one card, where you are vulnerable to the whims of the credit card company.
8. Don’t Neglect Personal Credit
While establishing a strong business credit rating is important, don’t overlook your personal credit rating. In most cases, however, it’s important that small businesses have both good business credit, as well as solid personal credit, on the part of the owners. Don’t neglect one at the expense of the other.
With proper planning, you can build strong business and personal credit ratings, and have the best of both worlds!
Learn More About Business Lines of Credit
Our upcoming book Finance Your Own Business: Get On The Financing Fast Track details the power of business credit, how to get an SBA loan, the secrets of micro lenders, the benefits of crowdfunding and more.
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About the Authors
Garrett Sutton, Esq., author of Start Your own Corporation, Run Your Own Corporation, Loopholes of Real Estate, The ABC’s of Getting Out of Debt, Writing Winning Business Plans and Buying and Selling a Business in the Rich Dad Advisors series, is an attorney with over twenty-five years experience in assisting individuals and businesses to determine their appropriate corporate structure, limit their liability, protect their assets and advance their financial, personal and credit success goals.
Gerri Detweiler is the author of four books, including the Ultimate Credit Handbook (named one of the top five personal finance books of the year when it was released), and a media favorite quoted in publications like USA Today, The Wall Street Journal and featured on The Today Show and CNN. A credit educator since 1987, she’s served on credit reporting agency Experian’s Consumer Advisory Council twice.