As a general rule, it’s best to keep your personal and business financials as separate as possible, but this can sometimes be difficult, especially as a small business. The distinction becomes blurry when it comes to your personal credit because it can greatly affect your business and available options.
Your personal credit is used as a reflection of your ability to handle your personal finances. As much as you may be able to keep work and life separate, your spending habits are probably similar between your personal and professional lives. If someone constantly makes late payments or has defaulted on a personal loan, then the same could be said of any future business loans or lines of credit.
Conversely, lenders assume if you have a good personal credit score, it means you will also be able to handle your business finances well. This is especially true for startups since the company doesn’t have a long track record of business credit to judge against.
Before you can understand the ways your personal credit can affect your business, it’s important to have a working knowledge of credit scores.
Your credit score, calculated each month, is determined based on a number of factors:
- Payment history
- Amounts owed
- Length of credit history
- Types of credit in use
- New credit
Sixty-five percent of your score is determined by the first two factors above: how much you owe and your payment history.
The amount owed factor is more precisely the amount of the credit limit you are using. The ratio of your outstanding credit card balance to your credit card limits, also known as your credit utilization, tells lenders if you’re overextended and therefore at a higher risk of defaulting on your loans. A low credit utilization shows that you’re only using a small amount of the credit that’s been loaned to you. A good utilization rate is less than 30%.
Your payment history is the most important factor in your credit score so on-time payments are the best thing you can do to improve or maintain your score.
TIP: Set up automatic payments if possible. Life gets hectic, especially life as a small business owner, so you’re bound to forget payments every once in a while. Automatic payments help keep you on track.
Effects Differ Based on Entity
In most cases, a small business is registered as either a sole proprietorship or an LLC. Your personal credit impacts both options, but in different magnitudes. Personal credit is connected to your Social Security Number (SSN) and business credit is linked to you by your Employer Identification Number (EIN) or Tax ID Number.
Operating your business as a sole proprietorship means you have not registered your business as its own legal entity with your state. It also means that, for all intents and purposes, your personal credit is your business credit, all linked to your SSN.
If you have bad credit, your business will not be approved for new loans or may have to pay higher interest rates because of your personal credit score and credit history. To be approved for better loans, you would need to either improve your personal credit or obtain an EIN and work to establish business credit.
On the other hand, as an LLC, your personal credit has an impact on your business, but not as strong as a sole proprietorship. With an LLC, business results are still reported on your personal tax return so lenders and credit card companies will likely ask for your business tax return or income statement to support new credit applications. But remember, if your business is new and doesn’t have a long enough credit history, then your personal credit score will be taken into account.
Business Credit and Loans
Lenders look at numerous factors to determine your eligibility for a business loan, including your personal credit. The better your personal credit score is, the more loan options you’ll have available to you. Not only does your credit score inform your approval or rejection, but it also determines your interest rate.
Even if you have an excellent personal credit score, you should still think about establishing business credit. In many cases, you won’t even be able to complete business transactions if your business doesn’t have credit. As discussed, lenders will use a business’s credit history to assess loan applications, and you’ll need credit to receive business insurance. In some instances, you won’t be able to buy goods and services for your business without access to credit.
If your business fails or experiences money trouble, without business credit, creditors look to your business assets to collect on the debt. But if the business assets aren’t enough to cover the debt, they can seize your personal assets, since you are liable for the expenses incurred by your business.
For small businesses to have the best chance at success, you need to have access to the best opportunities available to you. And since your personal credit score will be taken into account on numerous business financial levels, improving a bad score or maintaining a good one is vital.
Here are a few organizations that allow you to check your credit for free:
If you’re a business in Marion County, the Build Fund, operated by King Park, may be able to connect you to flexible, affordable, and responsible funding options for your business. Start the process now!