Small business owners often incorporate as a first step. This sets the business up as a separate legal entity to protect the owner from liability, among other advantages.
Many small business owners are surprised to find out that they are still on the hook for a small business loan. The Small Business Administration loan application packet has to include a personal history and a personal financial statement. The owner’s personal finances matter.
“In some cases it’s because the business has not established a sufficient business credit history,” says Gerri Detweiler, author of Finance Your Own Business: Get on the Financing Fast Track.” Or it may be because the business requires a personal guarantee and wants to check the owners personal credit to evaluate that risk,” she adds. Many small businesses lack assets, which is often why the owner is looking for funding in the first place. If the business relies on the owner’s expertise and enthusiasm, it also relies on the owner’s financial skills.
Even if the business has an operating history and tangible assets to use at collateral, Detweiler says that many lenders are looking at a small business credit score to help them make lending decisions. These are calculated by Experian, Dun & Bradstreet, and FICO; like a consumer credit score, they look at the willingness and ability of the borrower to repay loans based on past financial history. The most important of these for a small business borrower is the FICO SBSS score, which is used in SBA 7a loan applications of $350,000 or less. These scores are calculated based on a range of business background information, including information about the owner’s personal finances.
Whether you like it or not, your personal information matters.
For entrepreneurs with a good personal credit score, this is not a huge issue, although not all like the idea of having to disclose their personal financial information in order to get a business loan. Still, it’s a fact, and getting personal finances in order to be presented is one of the steps involved in preparing a loan application.
Not all entrepreneurs have great credit, though. In these situations, “they may need to look into options that are more forgiving,” Detweiler says. The good news is that number of alternative financing arrangements has been increasing. These include microloans offered by a Community Development Financial Institution (which often come with education programs that can help improve your business), crowdfunding, and merchant cash advances. In addition, a business may be able to finance inventory, accounts payable, and accounts receivable through factoring and trade credit. The costs may be higher than with an SBA loan, but they can keep the company in operations as it builds its financial position.
Someone who is thinking of starting a small business, like someone buying a house, should request a copy of their credit report to check for errors. Then, make a concerted effort to pay bills on time. It’s easy to overlook a payment in the press of life, but that will have a huge effect on a credit score.
And, of course, some day the business will be big enough that it stands alone. That idea makes the extra hassle worth it.