Despite this high
rate of usage, the terms of credit-card
financing are poorly understood. How many
entrepreneurs take the time to read the card
issuer's Terms of Use when they respond to a new
credit-card offer in the mail? This month's
column provides some guidance to entrepreneurs
who plan to use credit-card debt as a financing
technique and wish to understand the
implications of its personal guarantee.
Most
entrepreneurs shudder when faced with signing a
personal guarantee for a business credit card
for the first time. I've never really understood
how banks can market a product as a
"business line of credit" when it's
really a personal line of credit. However, since
the vast majority of businesses in the country
are sole proprietorships, the difference between
personal credit and business credit is murky
from a bank's perspective. Unless your business
is incorporated, you're the de facto
guarantor of all business debts. So if your
business has a slow sales quarter and you fall
behind on your credit-card payments, your
personal credit rating and your personal ability
to borrow are at risk. (For more information on
how to build your business's credit score, read
"Do
You Need Excellent Credit to Start a Business?.")
Even if your
business is incorporated, your bank or
credit-card issuer may still require you to
guarantee the business line of credit. In
practice, most banks require shareholders with
significant ownership in corporations to
guarantee business lines of credit--typically
owners with more than a 25-percent stake are
required to sign guarantee forms when credit
lines are more than $5,000. Moreover, most
guarantee forms require joint and several
liabilities, implying that all guarantors are
responsible for the whole amount of the debt,
even if they're not full owners of the business.
The guarantors can be sued individually or all
together. (This tends to vary from state to
state, so check with your attorney for details.)
If you're
attracting new partners to your business, be
sure to include a provision in the partnership
agreement that commits them to accept a personal
guarantee on all existing business debt. In many
states, new partners aren't automatically
responsible for previous debts, so this issue
must be addressed specifically. The goal is to
spread the liability as widely as possible to
reduce the risk to any one individual.
Keep in mind that
if you're establishing a credit line with a
community bank or local small-business lender,
there may be some room for negotiation. For
example, it's possible to request that certain
personal assets be excluded from the guarantee
or that the guaranteed percentage of the loan
declines as the business matures or surpasses a
certain net-worth threshold. Private loans from
relatives and other business associates are also
subject to negotiation. However, for credit-card
issuers, the offer for business credit is
usually a take-it-or-leave-it proposition--and
you must accept the personal guarantee if you
want the card.
For small
businesses struggling to find funding, borrowing
against a credit card can be an attractive--if
not the only--option. Plunging further into
credit-card debt is a scary proposition, but for
many the outcome has been rewarding. If you feel
using a credit card to fund all or part of your
business is the best option for you, be sure to
read the fine print before responding to your
next credit-card offer in the mail.
Understanding the risks before you accept the
offer can save you a lot of financial pain in
the future.
About the
author: Asheesh Advani is Entrepreneur.com's
"Startup
Financing" columnist and president of CircleLending,
a loan administration company that facilitates
loans among friends, relatives and business
associates. Get a copy of Circle Lending's free Small
Business Financing Guide for startups
