Can Your Personal Finance Hurt Your Startup?

India continues to be one the fastest growing hubs for startups in the world. In 2016, the country saw over 4,720 startup businesses, and major cities Bengaluru and Mumbai continue to be popular hub locations. If you are one of those startup owners, the chances are that your personal financial health is directly linked to the financial health of your business. In multinationals and public corporations, shareholders and directors are often limited to the amount of money invested. For a small business owner, this does not apply. Your personal finances can in short, determine how accessible capital is to your start up and therefore, determine your business’ projected growth.

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In a sole trader or unincorporated business, the term coined as unlimited liability applies. What this means is that the owner or partners in the business are responsible for the debts incurred by the business in its operations. More importantly, this limit does not stop at their initial capital but can extend to their personal assets and funds if needed. Therefore should the business go bankrupt, you can find yourself paying off creditors and debts for years to come. In fact, a recent study done by IBM’s Institute for Business Value and Oxford Economics found that almost 90 percent of startups fail within the first five years and one of the top three reasons was lack of funding. So how is this linked to your personal finance? Here are three ways your business can be affected.

Reduced Access

If you are going to be seeking external funding for your startup from banks, lenders or peer to peer platforms then be prepared to have your personal credit history checked including your credit score. There is general skepticism surrounding first time lenders and banks want to see solid business plans, ideas and contingency plans in place before deciding whether to grant your business loan.

If you have had missed payments in the past or even late payments, this can reflect negatively on your ability to repay your debts. To a creditor, this automatically raises the risk of doing business with you. Like investors, lenders are looking to get a satisfactory return. Any doubt about whether they will be paid back at all or even late will affect your interest rates and also whether it is a yes or no. If there are any missed payments or outstanding debts on your report, it is always good to get in touch with the lender and have a conversation with them about your options.

A poor credit background also affects your business’ ability to grow. So if your startup is already off the ground and you are now looking to expand into new markets or customer bases by using finance, your growth plans can be limited because of a poor credit background.

Higher Finance Costs

As mentioned in the previous paragraph, your personal credit past does not only affect the amount of access you have to external finance when applying for a business loan. It will also play a part in determining the cost of capital you will be paying. Higher risk clients will warrant higher interest rates from lenders to compensate them for the higher risks.

Other factors that influence the interest rate include the industry your startup will be based in, your debt to income ratio and stability of your business’ income. Your credit limits and interest rates charged can be determined using a blend of your credit score and other factors. Lenders will look at other debts you have when considering your application, including credit card debt. If you have outstanding personal debt or are thinking of filing for bankruptcy relief, chances are there will be financial consequences on your business. Before heading into a loan application it is good to access your credit report yourself so you are prepared. The earlier the better; if accessed regularly or in the initial stages of planning your startup, you can take proactive actions to rectify your score if needed.

No Legal Distinction

Finally, most startups that are approved for financing can have their assets seized if they cannot repay their debts or go bankrupt. If you have unlimited liability, then there is no legal distinction separating you and your business. Many small business owners end up personally borrowing loans to finance their company’s operations or personally guarantee business loans using personal assets as collateral. This only serves to further strengthen the link between your business’ borrowing and your personal credit. In the event of non repayment, your personal assets then stand to be seized as repayment of debts.

One of the best ways to avoid this is to establish your business as a separate legal entity. See your tax adviser for more information on the process. Another great step is establishing a separate business checking from incorporation, to help in separating business funds and identifying exactly how and what funds are being spent and where. Separating personal income from your business’ income helps you establish the correct taxable amounts end of the financial year and can also help you when applying for business finance. Lenders will be interested in how your business is performing; having it in isolation gives a fairer picture.

Similarly, if your business runs into financial difficulties it can also affect your personal finances. Therefore it is increasingly important that your business and personal affairs remain separated. If you are concerned about the financial implications of your personal finance on your company, make sure you seek professional advice from your credit adviser or accountant.

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