As a small business owner, one of the first actions to take is to structure business and ownership interests so that the debts of the business don't become the debts of the owner. Could your personal debt or bankruptcy filing drag your business down?
Know that an owner's personal creditors can seize business assets to satisfy the owner's personal debts. Here’s additional information about debt responsibilities and collections.
What is personal debt?
Also known as consumer debt, personal debt is the result of purchasing goods that are consumable and/or don't appreciate. If you and your spouse take out an auto loan together to purchase a car, this would be considered a personal debt. A personal debt can also be secured or unsecured.
What is business debt?
Business debt is typically anything that doesn't qualify as consumer debt. It's often referred to as non-consumer debt. Consumer debt is a debt incurred for primarily personal, family, or household purposes. Anything else is typically considered non-consumer debt.
Review your business structure
Most important, know that every business owner who has employees, no matter whether the business is organized as a corporation, LLC, partnership, or sole proprietorship, can become personally liable if the business doesn't pay the taxes it withheld from employees' paychecks.
Sole Proprietorships and Partnerships
If you're operating as a sole proprietorship, DBA, or as an independent contractor, you and your business are legally the same, and you personally owe every penny that your business can't pay. If your business doesn't have enough capital to pay its debts, creditors can, and sometimes will, seek payment from your personal assets -- or those that aren't protected by your state’s exemption laws. For general partnerships the debt belongs to each partner personally.
Corporations and LLCs
If your business is organized as a corporation or LLC, you and your business are separate legal entities. In theory, your personal liability for business debts is limited, meaning that creditors typically can't take your house or other personal assets to pay your business's debts, even if your business can't pay them.
Check the state’s laws where you operate so you are aware of your rights
The laws of different states affect how a collector can go after a debt. Resources to explore include:
- The Better Business Bureau’s published a list of debt collection laws by state will get you started.
- Contact your state attorney general’s office with questions.
- The National Association of Attorneys General has published a list of the state attorneys general where you can find yours.
Keep in mind that debt collector can make empty threats. If they claim to go after your bank accounts, it doesn’t mean they will be able to do so legally or successfully.
How personal debt affects a business loan application
Most growing companies or those looking to rebuild need outside funding for working capital. Working capital can be used for hiring, marketing, equipment, inventory, and more.
Your personal business score
Most lenders review your personal credit history, among other factors, in considering whether to take on the risk to grant you a business loan.
Your credit score is seen as a direct reflection of how responsible you are with money and if you’re a dependable borrower. If you can’t handle your personal finances, lenders might assume you won’t be able to manage your business finances. A newer business owner might not have business credit established so the personal credit score may be used. For more information about personal credit scores, visit the SmartBiz Small Business Blog:
- Personal Credit Scores: Important When Seeking a Small Business Loan
- Build and Manage Your Personal Credit Scores
Again, lenders want to know that you’re responsible in managing debt, including your personal debt. If you’ve defaulted on personal loans, credit cards, car payments, etc., you won’t be putting your best foot forward. A personal bankruptcy can also impact your ability to get a business loan. You can probably get a business loan after bankruptcy, but it will be more difficult – and most likely more expensive. Low-rates and long-terms are usually offered to those with a good personal financial history, among other requirements.
The bottom line – benefits of debt
Debt has many benefits over equity for many small business owners. There are many types of debt, from small business loans to MCAs, covering many types of businesses. The business owner does not need to share profits or decision-making with others and repayment terms should be clearly outlined by the lender.