Starting a business is exciting and filled with opportunities for success. Many entrepreneurs use loans from friends or family or rely on credit cards to finance their businesses. Although both of these financing methods seem innocuous at first, failing to make timely payments can affect personal relationships or have a negative impact on your credit score.
The following options can help you get the financing you need while protecting your creditworthiness and your relationships.
While equity financing helps fund a business by providing shares of the company’s ownership to those who provide the funds, debt financing leaves business ownership completely intact. Using this type of financing allows you to maintain ownership and leverage the maximum applicable tax deductions. In this type of business financing, your only obligation to the bank, private company, or other type of lender is to make timely repayments according to the contract. The payments must continue, even if your business fails, until the debt is paid off.
The Hartford notes that debt financing also simplifies budgeting and financial planning because you know the exact amount of interest and principal you must pay back every month. Making your payments on time keeps your credit rating (and your business) stable. Some potential disadvantages of debt financing include:
• Meeting the required credit rating (which varies among lenders)
• Having the discipline to make timely payments
• Risking some business assets as collateral to secure the financing
Rollover for Business Financing
Another alternative for funding your business, Rollovers as Business Startups (ROBS), allows you to use money in your retirement account to start your business. Individuals who choose this type of financing don’t take on additional debt, which protects their credit no matter the outcome. This financing method does put retirement accounts at risk, however, if the business fails, and it can result in hefty tax assessments—a 10% premature distribution penalty, according to the IRS—if it’s not done correctly. In addition to putting your retirement savings at risk, this type of financing can put you under increased scrutiny from the Internal Revenue Service, notes the Small Business Administration.
One of the benefits of using ROBS to fund your business is that it allows you to use your retirement funds without having to pay immediate taxes, according to the Small Business Administration. The basic process for using ROBS includes creating a new corporation and rolling your existing retirement plan over. The new 401K buys shares in the business, which provides funding for the business.
Keep Business Credit Separate
Protecting your personal finances is one way to build your credit for your business. By doing so, you can see an exponential increase in the amount of credit you can access compared to personal consumers, according to Entrepreneur magazine. Other benefits of keeping your business and personal credit files separate include:
• If your business fails or is sued, your personal savings and assets are protected
• It’s a simpler way to identify business expenses for taxes
• The clear, contractual obligation for paying off business credit provides firm deadlines and clear expectations
• Personal credit scores are protected from the effects of maxing out available credit to finance the business
More Tips for Protecting Your Credit
• Check your business credit report: Identity theft and fraud can wreak havoc on your credit, both business and personal. Keeping a close eye on your credit scores and reports helps identify fraudulent transactions quickly. You can check your two free credit scores, updated every 14 days, at Credit.com.
• Use caution when hiring other businesses: Before you start doing business with another company, it’s a smart idea to take a peek at that company’s business credit report to look for any red flags that could affect your credit standing down the line.
• Protect your ideas: According to Experian and the FBI, intellectual property theft costs approximately $250 billion annually. Use non-competition agreements and nondisclosure agreements to protect your inventions and ideas.
Constance Brinkley-Badgett is an editor and writer at Credit.com. Prior to joining, she worked as an editor for MSN.com, senior digital producer for CNBC, and digital producer for NBC Nightly News. She also is a graduate of the International Culinary Center in New York and has worked for chefs such as April Bloomfield and Jean Georges Vongerichten, and is the founder of Crave Personal Chef Services in Austin, Texas.