The Connection Between Business Credit and Personal Credit

Business owners looking to leverage their assets to build their companies often need to develop business credit lines separate from their personal credit histories. Understanding the connection between business credit and personal credit is key to creating prudent financial plans. It will also help you know what to do when your business struggles to pay its debts.

Business Credit vs Personal Credit

If you own a limited liability company (LLC) or corporation, your company is considered a separate legal entity independent of any of its owners. This is generally a good thing, because it isolates your personal assets from company creditors, keeping you from losing your home, vehicle, or savings when the company comes up short on its debts. However, to make this work, business owners (other than those operating a sole proprietorship or general partnership) need to maintain two separate lines of credit:

Business Credit Lines

Business credit lines are opened in the name of the business itself and are not linked to any of the company owners personally. The owners may have copies of the business credit cards, or be listed as signatories on business loans. However, unless you signed a “personal guarantee” there is no connection between this business credit account and your personal credit history.

Businesses’ credit scores are public, and they range from 1-100. Your business’s credit will depend on:

• The length of your credit history
• Credit utilization (the amount borrowed measured against the total amount of credit available to you)
• Payment history
• Other factors

Personal Credit Lines

You can also maintain personal credit lines separate from your business. Many small business owners take out mortgages or personal loans to generate start-up funds or keep the company afloat when times are hard. However, this does not necessarily mean the loan is business credit. As long as the loan is in your name individually, rather than your company’s name, it will show up on your credit history and affect your credit score, rather than your business’s. It is a good idea to memorialize any contributions you make to your business in this way, either by the company signing a promissory note (which it can pay back when it becomes profitable) or by giving you additional ownership (or equity) interest in the business in exchange for the investments.

Personal credit scores are private and can range from 300-850, based on the same factors listed above.

How to Build Business Credit

Having a strong business credit rating is important to building a successful and profitable business. It can allow you to:

• Obtain favorable financing from lenders and banks
• Negotiate better payment terms with creditors, vendors, and suppliers
• Reduce prepayments for goods and services

A new business must start to build business credit from zero. That means business owners must take active steps to create and maintain a separate business credit line. This requires:

1. Incorporating your business as an LLC or corporation
2. Obtaining federal tax identification number from the IRS (an EIN)
3. Opening and funding a business checking account in the company name
4. Opening a business credit file with the three credit reporting agencies: Experian, Equifax, and TransUnion
5. Applying for a business credit card with a company that reports payments to the credit reporting agencies
6. Creating lines of credit with vendors or suppliers and asking them to report your payment history to the credit reporting agencies
7. Using your business credit card for business-related purchases only (don’t mix personal and business expenses)
8. Keeping current on your payments

Remember that the (aspirational) goal is not to need credit!

The Connection Between Personal and Business Credit Ratings

Business best practices demand that you keep separate books for business and personal expenses, and account for any money that crosses from one to the other. However, total separation between business and personal financial affairs may be impractical, if not impossible for business start-ups.

The first time you apply for a business credit card, the creditor will likely make a “hard inquiry” into your personal credit history to determine if you are a trustworthy borrower. This can have a small negative impact on your personal credit rating. However, it will likely rebound within six months to a year. Some creditors (but not all) will also consider your business’s credit availability when calculating your personal credit utilization rate.

The most direct connection between personal and business credit comes in the form of personal guarantees. When you sign a lease for business space, apply for a business loan, or even open certain business credit accounts as a new business, your creditors may require you to sign a personal guarantee. This means you, as an individual, are cosigning on the loan with your company. If your business fails to pay its debts, the creditors can seek collections from you independently.

You can also create connections between your personal and business credit yourself if you aren’t careful to maintain separation in your finances. If you treat your business accounts as your personal funds, paying for personal expenses, depositing personal income, or easily transferring funds between personal and business accounts, it could open you up to personal claims by creditors looking to be paid. This is called “piercing the corporate veil.” Although very difficult to prove, a successful lawsuit based on this theory would allow creditors to collect payment for business debts from your personal assets (or vice versa) based on the fact that you treated the two accounts as one.

Will a Business Bankruptcy Affect Your Personal Credit?

While maintaining separate accounts and credit histories will work to your advantage if your company falls behind on its debts, the answer to this question can be complex and may depend upon whether your LLC or corporation files a Chapter 11 business bankruptcy, as well as the complexities of the credit reporting system itself.

At Lawrence & Jurkiewicz, we know how to help position small business owners to build their business credit and resolve their corporate debts which will, in the long run, help their personal credit scores. We will meet with you to review your financial circumstances and help you decide whether to file a Chapter 11 business bankruptcy, or whether another solution will be more appropriate to your situation. We want to help you make the right decisions for you and your business. Please call (860) 264-1551 or contact us for a consultation.