This series is designed to answer inquiries from readers who use personal credit to fund their companies. Even when a business is succeeding, your personal credit can be severely damaged by high balances carried on personal credit cards. Yes, you can use your personal credit without destroying it. This week I’m focusing on options for people with excellent credit.
While optimism is an essential component for any start-up, from a credit perspective it can be equally important to estimate your projected business income from a worst-case point of view. Last week, I urged you to develop a basic plan for your enterprise so you’ll know how much money you need for basic expenses until your business income covers your operating expenses.
Be honest with yourself about the cost of doing business and time required to develop income. It’s smarter to prepare for delayed cash now than to trash your personal credit covering bills later. When you know how much you need, it’s time to decide the best source for the money.
With a positive credit history, you have more options available when starting a business. Here are four possible sources of money:
- Home equity. Despite the tightening of requirements and elimination of home equity loans, if you own a home with a significant amount of equity this could be the easiest and most cost-effective way to fund your business. When you add the amount of money you want to borrow to the remaining mortgage due on your home, the total should fall below 70 percent of the appraised value. This ratio will qualify you for most lenders’ lowest fixed interest rates.
- Secure a personal, signature loan. Earlier this month I wrote about personal loans. (See my column, Two New Approaches to Personal Loans.) Sometimes an established relationship with a local bank can result in a personal loan with a reasonable interest rate. However, with increased credit tightening during the past year these loans tend to be more difficult to obtain from traditional banks. FirstAgain.com specializes in unsecured personal loans with competitive interest rates for individuals with solid credit histories.
- Use your savings as collateral. Credit unions have provided this service for generations. You can use your savings as collateral for a loan. Although it means you will be risking savings if you cannot repay the loan, with a low-risk business concept this can be an excellent way to raise capital.
- Apply for an SBA loan. Check in your area for banks that are SBA Preferred lenders. This means, in most situations, the bank will be able to approve your loan without waiting for the far lengthier, government processes of the Small Business Administration. And some of these banks will assist you with preparation of your loan package.
With any of the choices above, you will borrow a lump sum to finance your business. And you will not use personal credit cards to charge business expenses.
You will need to use your personal credit to qualify. However, since you budgeted for overhead your loan will pay you a salary, which will enable you to meet your expenses — including the monthly payments for the loan that will capitalize your business.
Earlier this year, I wrote a four-part series, You Can Build Awesome Business Credit. It lays out the basics to establish business credit and can be helpful information to use in tandem with this series.
You want to establish a legal entity for your business: a corporation or LLC (limited liability company). Each state has different laws governing business formation. Your state and the particulars of your business will determine the best decision for you. Basic incorporation processes are simple enough now that you’ll probably be able to handle them yourself. Do ask the advice of a highly qualified certified public accountant (CPA) or corporate attorney, who specializes in small businesses, before you commit to a corporate structure.
When your business entity is established, you’ve secured an employment identification number (EIN), and you’ve opened business bank accounts, it’s time to loan your business the money you borrowed. Draw up a simple loan agreement between you and your business entity. Have it notarized and store it in a safe place.
By legally loaning your company the money, your business will be able to repay the loan (to you) out of profits in the future and you will not need to claim it as ordinary income. In addition, your company will have a substantial bank balance when your business credit is checked. These steps will set you on your way to establishing excellent business credit while preserving and continuing to build your personal credit.