What do you need to start your own business? A quick Google search will find a good business idea at the top of the list, followed by a sound business plan and funding. You need money to start a business, after all. Without it, all you have is a dream.
So, where do you get the money to start a business? Unless you are among the few to experience the joys of inheriting generational wealth, you are going to need a source that is willing to fund you — either through extending a loan or investing in your idea. This is where credit plays a crucial role.
Personal and business credit: What is the difference?
Your first encounter with credit usually happens when you obtain your first credit card. The card gives you access to credit, which you can define as the ability to get something based on the promise that you will pay for it later. Those who are credit savvy work to increase the amount of credit they can access by making good on their promise to repay what was borrowed. Thus, they engage in building their personal credit.
“The value of building personal credit becomes clear when you start to make major life purchases like a new car or a home,” explains Keritan Shelby, CEO and Founder of JMS Consulting Firm. “Buying these items often requires a significant loan. The institutions that consider extending you that loan review your personal credit report to determine if you are a risk they are willing to assume. If your credit is bad — meaning you either have not borrowed much or you have not done well with repaying your loans — you typically won’t get the loan.”
JMS Consulting Firm provides credit consulting for both individuals and businesses, offering professional services for repairing and establishing credit. Keritan helps his business clients to understand how to properly establish business credit and get funding to scale their business the right way, without losing money in the process.
Business credit is similar to personal credit, except that it is based on your business’s financial performance, rather than your personal financial performance. Your personal credit activity is tracked through your social security number, whereas your business credit activity is tracked through the Employer Identification Number (EIN), also known as the Federal Employer Identification Number or Federal Tax Identification Number, and the Business’s Dun and Bradstreet (DUNS) number.
What are the pros and cons of each type of credit?
When you are in the process of starting a business, obtaining a business loan can be challenging because you have yet to build business credit, plus the business would normally have to be in business for a few years. As a result, entrepreneurs often leverage their personal credit for funding.
The pros to using personal loans for a business launch include more opportunities for obtaining loans and possibly lower interest rates. However, there are cons as well. Personal loan limits are typically smaller than those for business loans, and the fees associated with the loan may not be tax deductible as is the case with a business loan. Also, should you default on the loan, it will have an impact on your personal credit, rather than your business credit. Even if you repay the loan as promised, the financial activity will not contribute to increasing your business credit score.
“Many entrepreneurs don’t realize that there are ways to build your business credit quickly, obtaining access to working capital as you go,” Keritan explains. “Taking steps such as connecting with vendors who will extend credit, or utilizing store credit cards in your business’s name, allows you to establish a positive business credit profile quickly and become more lendable.”
Should I focus on building business credit?
Relying on your personal credit to grow your business may seem easier than working on establishing business credit, especially in the startup phase. However, choosing that route can add unnecessary stress that will make focusing on your business more challenging.
“Building a business takes capital; the more money you have access to, the faster you can grow,” says Keritan. “Many entrepreneurs use their own personal credit to fund their business, or they drain their personal savings and borrow money from family and friends. Not only does this present a threat to personal credit, but also to personal relationships. And none of it is necessary.”
If your goal is growing a business, establishing solid business credit is something that cannot be avoided. And it is a goal that you should start pursuing as soon as possible. The financial life of a business — paying for day-to-day expenses, covering payroll, funding expansion, and more — rely on it. Drawing on personal credit may be necessary as a short-term solution, but it is only better for business if it serves as a step toward establishing business credit.
