Most business owners are aware of how important their personal credit is, but only when it comes to their personal finances. Personal credit affects one’s ability to qualify for loans, and credit cards, and the interest rates one can expect to pay when utilizing credit.
A favorable personal credit rating can even improve one’s chances of getting a job.
Some business owners may not be aware that the manner in which personal finances are managed can bleed over into other aspects of life. Some small business owners may not be aware that their personal credit rating can also have a pronounced effect on their business’s chances for success.
So, how does personal credit affect business credit, and what can business owners do to make their personal credit an asset to their businesses, rather than a liability?
Learning Good Habits
Many of the same rules to building a solid personal credit rating also apply to the business arena. For example, bills should be paid on time (preferably early), and the business’s credit rating should be monitored. Disputes should be filed on any erroneous items that appear on the credit report. Balances on credit cards should be kept below 30-50%, and debt should be used responsibly.
If these guidelines are being followed, then a good credit rating should naturally follow. And, those who manage their personal credit ratings well are more likely to do the same for their business credit.
What Lenders Look For
When starting a new business, it can be quite difficult to qualify for financing such business loans, business credit cards, or lines of credit. Banks are apprehensive to lend money to businesses with no credit history. And of course, it makes good business sense for lenders to want some strong evidence that the businesses to which they are extending credit can be relied upon to repay the debt. After all, banks don’t make money by gambling on long shots.
So what do banks look at when considering extending credit to new businesses? More often than not, they look at the personal credit of the business’s principals. If those who are running the business have good credit, they tend to be more responsible when it comes to managing business debt, as well.
Additionally, financial institutions will typically require new business owners who are applying for business loans to personally guarantee the loans. When someone signs as a personal guarantor, they are backing the loan with their personal assets. If the business defaults on the payments, then the personal guarantor is legally responsible for the debt.
However, if the owner of the business has poor credit, then their personal guarantee is unlikely to be very persuasive, in the eyes of the loan officer. No matter how persuasive the pitch, and how earnest the entrepreneur, the days of doing business on a firm handshake have long since ended.
After all, if someone can’t manage their personal debt responsibly, then how likely are they to be prudent when it comes to managing business debt? Further, if the business fails, how likely is it that the person with poor credit will be willing or able to fulfill the obligations of the loan?
The answer to both of these questions, as far as the bank is concerned, is “not very.”
Getting a Head Start
The best practice is, of course, to manage one’s personal and business credit ratings responsibly, and to start doing so long before qualifying for a business (or personal) loan becomes an outright necessity. Having the necessary elements in place ahead of time can help a business owner to qualify for financing at reasonable rates, without putting up excessive collateral.