For many aspiring business owners, a major hurdle to launching a business is obtaining enough capital for the launch. Depending on the nature of the business, it might cost tens of thousands of dollars or more to open a new business’s doors. Even after the business is up and running, it could take months or even years to turn a decent profit. In some cases, an extra infusion of cash is needed after the launch. New business owners often take on personal debt to fund both their business and their personal lives. However, doing so comes with significant risks. These are the top reasons why new business owners should not take on personal debt when starting a new business.
1- Personal and Business Credit Scores
While your business credit score cannot affect your personal credit score, your personal credit score does affect your business credit score. Taking on debt now, such as a personal loan or charging up a credit card, can impact your ability to access credit in the future. This is particularly problematic if you default on a loan or have late payments that lower your credit rating. Whether your credit scores are low today or may drop in the future because of a tight financial situation that requires you to take on personal debt, you may be putting your business in a disadvantageous position.
2- Business Financing
When applying for a business loan, lenders and banks often look at both the business’s finances and the applicant’s personal finances. Specifically, they look at factors like your debt-to-income ratio, the total amount of debt that you carry, and your assets. Your personal debt balances and monthly payments directly affect these factors. This is particularly true if you apply for a recourse loan or if your business operates as a sole proprietorship or partnership. In some cases, business owners must take steps to reduce their personal debts in order to qualify for a business loan. It is best to get your personal finances in order before starting a business.
3- Personal Liability
While taking out a personal loan or increasing personal debt when launching a business has pitfalls, taking on a business loan can also be detrimental in some cases. Depending on the type of business entity that you set up, you could be personally liable for the debts of your business. For example, if you have a partnership or sole proprietorship, you could be subject to personal recourse if you fail to pay your business debts. This means that if you do not pay your business loan as agreed, for example, the creditors can come after your personal assets.
Explore Ways to Manage Your Finances Today
Because your personal finances directly affect your business and its access to credit, it is imperative that you make necessary changes to your personal financial situation before launching a new business. Depending on your current situation, you might need to save more money, reduce debt balances, or improve your personal credit score as first steps.
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