Are You Personally Liable for Your Business Debts?

Donald Trump is famous for his mantra, “It’s nothing personal, it’s just business.” While this seems like a harmless platitude, it’s not always true. Business finances and personal finances are not necessarily mutually exclusive; entrepreneurs may tap into personal finances to keep their businesses afloat, and when it’s time for a small business loan, the two are tied together.

If you’re an entrepreneur, it is imperative that you know how business financial decisions can affect your personal assets and personal credit. It comes down to knowledge and good decision-making.

Here are three risks you should be aware of as a small business owner and the best ways to protect your personal resources.  

1. Limit the amount of personal assets that you put into your business.

Risk: When starting a new business, it’s hard to get a traditional business loan because your company doesn’t have a proven track record. As a result, many startup owners pull money from personal savings to capitalize their businesses.

According to Susan Wilson Solovic, author of The Girls’ Guide to Building a Million-Dollar Business, women in particular tend to start a business with personal funds.

Using personal assets to start a business is practical but risky. In the short term, it shrinks your rainy-day fund. Every entrepreneur should hope for the best, but if your business doesn’t succeed in the long term, your hard-earned personal assets could be lost along with it.

Solution: See if you can take some of the load off your shoulders by getting loans or raising equity from family and friends. A lot of women don’t consider their personal network when searching for business financing, which leads them to invest a disproportionate amount of their own money in a business.

After tapping your network, if you do decide to use your own money, consider leaving at least six months’ worth of personal expenses in a savings account to give yourself some breathing room if the business doesn’t grow as fast as you expected.

2. Understand the effect of a personal guarantee.

Risk: Even if you don’t pour personal assets into a business, it doesn’t mean that those assets aren’t at risk. While there are some unsecured business loan options, most business loans require personal guarantees from the primary business owners.

A personal guarantee allows lenders to repossess your home, car, and other personal assets if you default on a loan, and use the proceeds to pay off the outstanding balance.   

Solution: Use your negotiating skills. If you’re borrowing a significant sum of money and your business is performing well, some lenders will limit the amount of the loan that you have to personally guarantee or the length of time for which you have to personally guarantee it.

If negotiating isn’t helpful, consider going into business with partners. Personal guarantees are typically required for all individuals who own at least 20 percent of the business, so having partners divides up personal responsibility if the business defaults.  

3. Make business loan payments on time to shield your personal credit score.

Risk: Even if you manage to get a business loan without a personal guarantee, your personal credit score can still be affected. Some lenders report business loans to consumer credit bureaus. This can hurt your personal credit score because the business loan raises your overall debt level.

Solution: Ask the lender about their credit reporting policy before commiting to the loan, and make every loan payment on time.

Most lenders don’t report business loans to consumer credit agencies unless the borrower falls behind on payments. For example, Chase and American Express only report untimely payments on their small business credit cards to consumer credit bureaus. Even if your business lender reports all payment activity to consumer credit bureaus, the impact on your credit score will be small if you’re paying the loan off on time.

For many entrepreneurs, it’s necessary to use personal savings to get a business going or to provide a personal guarantee on a business loan. Before any papers are signed, make sure you understand how your personal assets are at stake and evaluate the risks before proceeding.  

Priyanka Prakash is a member of the DailyWorth Connect program. Read more about the program here.

Join the Discussion