For many small business owners, business and personal lives often overlap. And this is particularly true when the owner runs the company full-time. Everyday family and personal tasks get co-mingled with professional responsibilities like dealing with vendors, customers, and employees. I talk to hundreds of entrepreneurs a month, and I always hear about their jam-packed schedules, full of client meetings and trade shows, soccer practices and family vacations.
Of course, when the revenue of the company is the sole or chief source of income for the entrepreneur and her family, the line between the business and personal gets blurred even more. Small Business Trends recently had a very helpful post explaining the effect of an owner’s personal credit on small business borrowing, highlighting three main drivers:
- Personal credit score as a predictor of small business loan repayment
- The abundance of small businesses legally organized as sole proprietorships
- The use of personal guarantees and personal credit AVAILABILITY to finance the company
Personal Credit Score
Based on Federal Reserve data, Small Business Trends noted that personal credit scoring is a relatively good way for large banks to predict repayment on loans of less than $100,000. In many cases, the earnings of an established small business are the main source of income for the owner, so a good personal credit score is a useful proxy for the performance of the business as a whole. After all, if all of your money comes from your business and you are managing your credit well, the the cash flow generated by the business must be sufficient for you to pay your bills.
Another factor contributing to the interplay between small business loans and personal credit is the way many small businesses are legally structured. Citing IRS data, Small Business Trends noted that 72% of U.S. small businesses are organized as sole proprietorships, meaning that there is no legal separation between business and personal assets. Consequently, personal credit scoring becomes a crucial factor for many small business lenders. For this reason, many banks and finance companies will not lend to sole proprietorships at all. This is one area where we are different. Dealstruck has and will continue to lend to qualified sole proprietors—a crucial component of the small business ecosystem.
Personal Credit to Finance Business Debts
The final factor highlighted in the recent piece is the way in which many loans are secured. Approximately one quarter of all small businesses are funded through personal credit cards and home equity-based borrowing by the founders. In fact, according to Intuit data, $150 billion of outstanding PERSONAL credit card debt (to say nothing of BUSINESS credit cards) has been used to finance small businesses—a number that nearly equals the total value of non-real estate small business loans smaller than $250,000!
Clearly, and many times early on, entrepreneurs lean on their personal balance sheets to finance their small business dreams—sometimes heavily. This is where I think the use of personal credit scoring as a primary driver for small business loan decisioning can miss the mark. Keep in mind that banks generally only lend to firmly established businesses. These businesses are generally successful and seasoned enough to have alleviated the burden placed on the owner’s personal credit.
However, for the business owner who has financed the company using personal savings and credit, the very money that fueled the growth of the company to begin with may have negatively impacted his personal credit—hamstringing the company from obtaining cost-effective capital at the point of maximum need and benefit.
Dealstruck will always strive to lend to small businesses whose owners have poured their efforts and personal wealth into pursuing their entrepreneurial dreams. If the company exhibits solid growth fundamentals at the expense of a weaker credit score, we see very little reason not to help that company take the next step with one of our affordable loan option.
When seeking business financing, be aware of the personal elements lenders will use to determine your business’s credit-worthiness, and then give us a call.