Most small business owners use some measure of personal funding to get their startups off the ground. They may dip into their savings account or refinance a mortgage. And most will break out their personal credit cards to pay for the supplies, services, or equipment they need to launch.
Over time, however, smart business owners come to understand that it’s a good idea to establish a line of business credit and keep it separate from their personal credit. This prevents any financial problems their business has from damaging their personal credit rating.
The first step in building a wall between business and personal finance is to incorporate as a corporation or as a limited liability corporation (known as an LLC). This will shield your personal assets from any business liabilities should your enterprise take a turn for the worse. Once you’ve incorporated, you can start building your business credit profile. (You can also build a business credit profile as a sole proprietor or as a partnership, but if you do you’ll still be personally responsible for any debts owed by your company.)
Establishing strong business credit is an essential step in ensuring the success of your business. It can put you in a better position to secure capital in the future, save you money by lowering your interest rate, improve cash flow, enhance your credibility, and make it easier for you to buy the equipment you need to grow.
After you’ve established a business line of credit and (ideally) built an outstanding credit score, you’ll have a stronger chance of getting a loan in the future and even better, you can save money by securing a lower interest rate on the loan. Then the money you save on interest payments can be invested to bolster your business instead of your bank’s business.
A high credit score can also polish your image with suppliers and attract new customers. These days, most suppliers and potential customers will take a look at your credit report to make sure your business is sound before they sign any contracts. If they see a rosy credit score next to your name, they’ll feel confident enough to enter into a business relationship with you.
Now let’s look at the other side of the card. Suppose you haven’t established a strong business credit profile. Imagine you run a graphic-design business and you sign a new client and you need to buy several new PCs to handle the increased workload. But since your corporate credit is weak you need to pay for the new PCs with your personal credit card. Then two months later you need to buy a color printer with your personal credit card. But each time you get out your personal card to cover business expenses, you dent your personal credit score. And when you do that, you make it more difficult to get financing for your business.
A lot of business owners anticipate this problem and obtain a business credit card or two to avoid it. They figure that if they have a credit card account with the name of their business on it, they can’t be held personally responsible if their business goes under. But a lot of them realize only too late that they’ve made a mistake.
Often, when you apply for a small business loan, line of credit, or credit card, you’ll be required to back it with your personal credit. But this personal guarantee exposes you to any debt your business racks up down the road.
If you want to avoid this responsibility (and you should) then don’t establish your business as a sole proprietorship or partnership. Instead set up your business as a corporation or LLC. That will shield you from any liabilities incurred by your business.
Another important rule to follow: Never use your Social Security Number when applying for a credit card or a line of credit — or in any financial transaction related to your business. This opens the door to your personal assets. Instead give your business’ federal tax identification number or your employer ID number. This will keep that door closed and locked.
In this era of very tight credit, more and more business owners find their business credit options getting squeezed. That’s why it’s more important than ever to build a strong business credit profile. And why you should take steps to separate your business credit from your personal credit. If something does go wrong in your business, you can move ahead and perhaps start again.
Tim Devaney is a business and technology writer. He has also been a senior editor at Red Herring, Industry Standard and San Francisco magazines, and editor-in-chief at the Berkeley Monthly and Peninsula magazine.