Did you know that two most common business funding methods entrepreneurs use when starting their ventures are friends and family and credit cards? When you think about it, it’s not difficult to see why – friends and family members usually offer very easy terms, and credit cards are readily available.
While family and friends may be an easy option for some, credit cards offer a more independent way to fund your new business without putting others at risk. You don’t have to prove your idea to anyone or get them to agree your idea is the best thing sliced bread. You also don’t need to give away equity or face rejection from people who don’t get your idea. With these factors in mind, it’s not surprising to see that funding through credit cards is such a popular choice.
The caveat, however, is that while popular, many people don’t understand how to use credit cards wisely. The biggest problem you may encounter with using credit cards as funding is when you go the personal credit route. Since startups typically have no business credit, the entrepreneur is forced to use his or her own credit to fund the business.
In addition, there are a few other issues to be know about:
The first is the problem that can come from co-mingling personal and business finances. If things go south, co-mingling endangers your personal assets and personal credit. In addition, if you are ever audited, co-mingling is not something the IRS likes to see. Similarly, if you are ever sued, co-mingling is evidence that your corporation is but a shell and should possibly be voided. This is called “piercing the corporate veil.” We do not like when our corporate veil is pierced. And finally, keeping your business finances separate from your personal finances allows you to build your business credit profile.
But the most significant downside when using your own credit cards to fund your business, and the biggest risk, is that you will be personally liable for business debts. Given that one of the main, and very basic reasons to incorporate is to protect your personal assets from business liabilities, putting your own credit and assets at risk by using your personal credit cards to fund your business is not highly recommended.
All that is well and good you say, but what if you can’t get business credit? That is a short-term problem that is fairly easily rectified. Here are the basic steps:
- The first thing to do is to incorporate so that the business is a legal entity separate and apart from yourself.
- Next, get a federal tax ID number from the IRS, also called an EIN (for Employer Identification Number.)
- Next, open up a checking account using the business name and tax ID number. Open up a small savings account as well (less than $1,000 will work fine.)
- Use the business name and EIN number to establish basic services – telephone, Internet, FedEx accounts, that sort of thing.
- Then, look to get a small loan from your bank – in the name of the business – secured by that business savings account. The collateral of the bank account makes approval much more likely.
- Make sure the bank reports the loan repayment history to the credit reporting agencies, as well as Dun & Bradstreet.
- After a year or so of this, start to apply for credit cards in the name of the business. Be sure to apply for cards that do not tie your business credit in with your personal credit, or where you personally guarantee the business credit.
If you follow this simple strategy, in a year or so, you will have a solid business credit profile and will not need to ever comingle your business and personal finances again.