When you are your business, as is the case for many small or family-run businesses, the lines between personal and business finances can become blurred.
This can be problematic down the line because, although there is a distinction between the two, when it comes time to borrow lenders can and do look at your personal financial activity to assess your suitability for business credit.
This relationship between personal and business credit can be a source of anxiety for small business owners and startups, whether they have an unblemished record or a less salubrious personal credit history. Many business owners have valid concerns about their access to borrowing should the need arise during periods of business growth, or in order to solve cash flow issues.
The odd late payment here, a refused credit card application there, and before you know it, your credit score can take a bit of a battering. But, as we have discussed before, cash flow is essential for business survival, and in the early stages sometimes cash flow can only come with a bit of a boost from borrowing. So what happens when you need to achieve business credit, but there are a few dinks on your own personal credit file? Is it game over?
Well, it can be for some, particularly if they don’t think outside the box.
How do lenders evaluate business creditworthiness?
There is, of course, a distinction between personal and business finance, but to fully understand how the two are linked it is necessary to understand what information is held on your business credit file and how it is used by some lenders to make decisions.
When searching your business credit history, lenders will have access to all or some information about previous borrowing and your repayment behaviour, details of ownership and director information, trade credit agreements, your previous credit applications and their outcomes, any previous County Court Judgements (CCJs), your company accounts and overall existing credit and this wealth of data is increasing as people increasingly live their personal and business lives on-line enabling AI credit searches to include social media profiles across multiple platforms, further blurring the lines
From that information, lenders will establish how much perceived risk is involved in lending to you and make a decision. The higher the risk, the higher their interest rates and the lower the amount you will be able to borrow – or the lower the likelihood you will be able to borrow at all.
But what if there isn’t much history to base a decision on?
As with personal credit when there is a lack of credit history there is perceived risk – and there is, therefore, a chicken and egg scenario to overcome.
When startups or companies without much trading or borrowing history apply for business finance there is limited information about company activity. As a result there is limited information on which to base lending decisions. In this case, lenders may consider personal history.
Although personal financial behaviour is not always a reliable measure or indication of business creditworthiness, a combination of business and personal financial history can be used to build a picture that can better inform a potential lender.
Here the new blended commercial scoring tools that integrate business and personal financial information can come into play, and this is when any personal financial indiscretions can end up coming back to haunt you.
Can business credit affect personal credit?
In terms of crude credit referencing, the answer is not usually – although it depends on how your personal account has been referenced if a lender has used your personal credit file to make an assessment for business credit and it a previous business has failed.
There are two types of searches lenders can carry out – so-called ‘hard’ and ‘soft’ inquiries. A soft search should have little to no effect, but a hard search will appear on your personal credit file and could count towards your personal credit limit. If the application for credit was denied, this will result in a real-terms drop in your personal credit score.
What about when people use personal credit to fund their business?
There are more literal, and much more damaging ways that some small business owners find themselves with their personal finances negatively impacted through funding their business. Many small business owners actually end up using personal credit to bail out their business, and this puts them at substantial risk of personal financial ruin should the business ever run into difficulties. When capital is secured against homes or other personal assets, this can leave individual business owners particularly vulnerable.
In February we explored the human cost of the UK’s late payment culture, and how late paying clients can plunge SMEs deep into dangerous water with cash flow difficulties, resulting in 17% of respondents in a survey by the Prompt Payment Directory being forced to remortgage to make up the deficit caused by late payers or bad debt.
No business owner should be forced into a financial corner, especially when there are alternative finance options available.
If you find yourself in the position of having business credit refused, by your Bank or you are thinking of securing loans to your commercial business using your personal assets , then alternative finance could be the answer you are looking for. As if you offer credit terms to your business clients then you may be able to secure short-term lending using these unpaid invoices. This “invoice finance” can provide access to working capital that grows as you grow without tangling business and personal finances, by effectively turning sales made on credit into cash sales and it can even include outsource credit control as part of the service..
Using invoice finance can improve your business credit
Having the flexibility to access working capital without turning to traditional lending can ensure that you have the ability to pay your suppliers on time, every time, increasing your credit score, reputation and your credibility. Your creditworthiness is all about your reliability and how your financial behaviour is perceived by lenders. If your business runs into cash flow difficulties, the first thing to slip is often payments to suppliers you have credit terms with. This can lead to loss of trust with suppliers, and often result in youmissing out on preferential credit terms or early payment discounts, all of which impact the bottom line.
Partnership Invoice Finance is dedicated to providing a personal, flexible invoice factoring and financing service, that can give you a cash injection when your most need it, allowing you to access working capital without adversely affecting your credit rating, or weighing you down with debt. To find out more about how we can work together, contact us.