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Updated on Friday, November 20, 2015
The allure of being your own boss — it’s something we can all dream about, right? Although you probably already know that opening a small business takes a lot of hard work, determination and late hours, there are bound to be a few things you might not have considered.
MagnifyMoney’s co-founder Nick Clements spent years working for banks that made loans and issued credit cards to small business owners before launching his own small business. Here are some of the most important things he discovered along the way.
1. Your Small Business Isn’t Borrowing — You Are
Most people who launch small businesses do so by taking out loans to pay for things, or by opening new credit cards specifically for that business. It’s important to realize that as the owner, you’ll most likely be taking personal liability for whatever you borrow for your business, as well. “In other words, if your business goes bankrupt, you will still be personally responsible for the debt,” says Clements. With that in mind, he warns new small business owners against separating the idea of spending on a small business credit card or taking out a loan from a marketplace lender from their own personal expenses. “If you think this debt will not affect your personal financial situation, it will,” he said. “So long as you are making payments on time, the debt from your small business credit card likely will not appear on your personal credit report. However, most credit card companies will start reporting the debt on your personal credit report as soon as you start missing payments.”
2. Small Business Loans Have Less Protection
The CARD Act of 2009 created many consumer protections for credit card use, but the same isn’t true for small businesses. “Many of the protections found in The CARD Act only apply to consumer credit cards,” said Clements. “So if you take out a small business credit card, you will not have those same protections.”
The biggest risk of a small business credit card is that the interest rate on your existing balance can be increased. That was banned for consumer cards, but can still happen on small business cards. You also need to be careful if you are shopping for a loan. Small business lenders do not have to report an annualized interest rate in the way that consumer lenders do, and some products offered by small business lenders can have complicated pricing structures. “Unless you annualize the interest rate, you cannot compare,” says Clements. “For example, you could be offered a 4% fee on a cash advance product. However, if the full repayment is due within 30 days, that means your annualized interest rate could be 48% or higher.”
3. Your Personal Credit Score Will Affect Your Business
Your ability to get approved for small business credit cards and loans will largely be determined by your personal credit score, so be sure to stay on top of that in the weeks and months leading up your small business launch, as well as after. “If you are so focused on building your business that you forget to make some payments on your own accounts, you will be doing harm to your business as well,” said Clements. “Both small business credit card companies and marketplace lenders still heavily use FICO and other individual credit scores when making a lending decision.”
4. Borrowing Shouldn’t Delay Difficult Decisions
When you’re a small business owner, you will occasionally have to make some hard decisions, and the ability to borrow money to stay afloat can sometimes interfere with making the smart choice. “If your small business is having difficulties, you will often find people willing to lend you a lot of money at high interest rates,” says Clements. “Although it might feel easier to borrow the money and keep going, you are only building a bigger problem for yourself.” Instead, Clements suggests taking a serious look at whether it’s time to reduce costs, or even exit the business completely. “Again, remember that you will likely be personally liable for any money you borrow,” he cautions.
At the end of the day, opening a small business comes with a lot of risks, but there are just as many rewards. Keeping the above things in mind, you can move forward knowing you’re making smart financial decisions — both for your business and for yourself.