A very common (and costly) mistake that I see many business owners make is a failure to separate business and personal debt and credit. Entrepreneurs are eager go-getters by nature, and are ready to jump in and get started with their business the moment they have their EIN and all their corporate documents. Many business owners mistakenly assume that getting a corporation set up is all they need to do to protect their personal assets. If you are putting business expenses on your personal credit profile, like a credit card or HELOC listed under your name and social security number, you are opening yourself up to personal liability and the risk of fines and other government penalties. Just as you set up a corporation to protect your personal assets, you need to set up your corporate credit profile to protect your personal credit, and completely avoid commingling any and all personal and business expenses.
There are many reasons to keep the two separate: firstly, as mentioned, this protects your personal credit profile; any debt going under your SSN instead of your EIN shows up on your personal profile as personal debt, which will artificially inflate your credit utilization; this will cause your credit score to go down, since your debt-to-available credit ratio and your debt-to-income ratio will show as higher than normal. Additionally, lenders offer different terms and higher loan amounts for funds being used for business purposes because they know the money will be used to make more money; you’re not taking that credit card, for example, and going on a shopping spree, you’re using it to invest in your business. So, having credit lines under the company offers benefits exclusive to businesses.
A much more serious consequence, however, is that convoluting the two can end up piercing your corporate veil. As any corporate attorney will tell you, this can result in personal liabilities, both legally and financially, if something negative happens to the corporation. It can also incur IRS fees if you’re audited, and revocation of your corporate status with the Secretary of State. Of course, we always hope for the best, but as a diligent business owner, you must be prepared for unfortunate circumstances, whether that be financial distress within the business or legal matters that may arise in your company.
By separating the two, you are also starting to build your corporate credit profile and Dunn & Bradstreet, which is very important as your business grows and you need to borrow larger sums of money and layer your financing further. Building a corporation’s credit will allow your business to borrow without a personal guarantee (also called a signature loan).
So, how do you do this? Separating the two from the beginning is easy: just ensure you are always applying for and taking financing that is specifically for business use and reporting under the EIN, not your SSN. Oftentimes, a personal guarantee is needed, and personal credit is pulled and reviewed during the application process (until you establish corporate credit). When the loan is taken, however, it does not show as available credit or debt under your personal credit profile. The only exception to this is in the event of a default on the loan, that is really the only situation business debt can negatively impact your personal credit profile.
So, what if you haven’t separated the two? What if you’re in business and have already put expenses on your personal profile? The best option is to see what you can obtain for business funding and use that to pay off anything that is a business expense that was paid for using a personal credit card or other personal debt instrument. This has to be done on a case by case basis and can take some time and expertise, so consult with an expert for available options and the best way to get this debt off of your personal profile and under the business.