Great credit scores don’t happen by accident. They take hard work and consistency to earn.
If you have brag-worthy personal credit scores, you’ve probably spent years building those scores and protecting them from damage.
There’s no question that your personal credit can be an asset when you need to borrow money for your business. However, there’s also a deeper level of risk involved whenever you put your personal credit and finances on the line to vouch for your company.
It’s fine to use your personal credit to help your business get ahead. But you shouldn’t do so without good reason or without understanding the potential downside.
What Is a Personal Guarantee?
A personal guarantee is a promise made to personally repay the money a lender issues to your business in the event your company fails to pay back the financial obligation as agreed. A personal guarantee essentially makes you a co-signer on a business debt.
Lenders ask for personal guarantees because it reduces their risk when you, the business owner, have some skin in the game. If you have good personal credit, you may be able to secure higher limits, lower interest rates, and better terms on business financing.
Should You Sign a Personal Guarantee?
Before you agree to use your personal credit to secure business financing, it’s crucial to understand the potential problems you could face if things go badly. A personal guarantee may reduce risk for lenders, but it increases risk for the person who is signing it.
When you sign a personal guarantee, here’s a look at what you might be putting on the line to help your company secure financing.
- Your personal finances
- Your personal credit rating
- Your personal assets (e.g. home, car, real estate, bank accounts, etc.)
Your goal should be to eventually avoid personal guarantees as much as you can. Unfortunately, it’s not always easy to steer clear of this requirement if your business is young or hasn’t yet established a strong business credit rating.
While there are some lenders willing to grant loans without a personal guarantee, the truth is that it’s typically more challenging to build business credit without accepting some personal liability. There are even some types of financing, like SBA loans, that may be impossible to qualify for without a personal guarantee.
If the risk makes sense and you’re comfortable putting your name on the line to secure funding, it’s okay to use your personal credit for your business. If you’re not comfortable with the risk, you should probably avoid it. Only you can make that decision.
Avoid Using Personal Credit Cards for Business
According to a Nav study, small business owners have nearly twice as many credit cards as consumers. Their credit limits are also almost twice as high. While there’s nothing wrong with having numerous credit cards and higher credit limits (as long as they’re well managed), these numbers may be the sign of a troubling problem.
Nav’s Education Director, Gerri Detweiler, explains “it can be hard for young businesses to get funding, so some small business owners are using personal credit cards to fund their startup costs and operations, but this can be a dangerous practice.”
Detweiler points out that funding business expenses with personal credit cards can be problematic for two reasons.
- High credit limit utilization on personal cards can damage your personal credit scores.
- Using personal credit cards instead of business cards robs you of the opportunity to build credit history for your company.
Instead of using a personal card to cover business expenses, a small business credit card is typically a much better fit. Although small business cards almost always require a personal guarantee, many business cards won’t report to the personal credit bureaus (as long as you’re on time with your payments). This can protect you from lower credit scores in the event you ever run up a high utilization rate on a business credit card.
Just keep in mind, should you sign a personal guarantee for a business credit card, you’ll still be on the hook if your business fails to pay as agreed. Best practices for managing any type of credit card (personal or business) involve paying your balance in full each and every month. When you follow this rule of thumb, you’ll avoid spending money on high interest fees plus you’ll protect your credit scores from potentially being lowered due to high utilization.
How to Build Business Credit
If you want to avoid personal guarantees in the future and keep your business and personal credit separate, it’s important to take the time to build a solid business credit profile. Opening vendor accounts (aka trade credit) and small business credit cards can be a great start. It’s also a good idea to keep your bills paid on time and pay your credit card balances off in full each month.
Ready to get the process started? Check out this 14-step checklist to make your business legit. You can also keep an eye on your business and personal credit scores courtesy of your free Nav account.
This article was originally written on May 23, 2019.
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