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| The #1 Business Mistake That Can Ruin an Entrepreneur’s Personal Finances Posted: 18 Oct 2020 07:00 AM PDT By Alex Ormond I have been wanting to write this post for a very long time. Out of hundreds of business owners—either current or prospective—that I speak to on a regular basis, nearly one-half tell me they are about to commit the mistake I discuss in this post without realizing how it can set back their personal finances. In fact, you might consider this post a public service announcement, because the ease of making this mistake, coupled with its long-term effect on your personal financial well-being, is shocking. I am talking about using a personal line of credit to fund your business. On paper, this process does not sound catastrophic, dangerous, or worrisome. In fact, it sounds logical and easy. The typical thought process individuals share with me is as follows: You are passionate about starting a business or maybe buying an existing one, you have a good credit history, and the bank has given you access to a line of credit. It is sitting there waiting to be used and you realize that it’s an easy way to fund your dream of entrepreneurship—be it buying computers, equipment, paying yourself a salary, or depending on how large your line of credit is, even buying a business. You can simply take the money out of your personal line of credit and transfer it to your business. Easy! In reality, however, this simple transaction can decimate your personal financial well-being, cut off your personal access to credit, suck you into a whirlpool of high interest rates, and leave you with a subpar credit rating for years to come. A cautionary taleA few years ago, I met David (name changed) and his wife for coffee. David was interested in buying a ski equipment shop where he worked from its then current owner. Both David and his wife were in their early 30s, did not have kids, but wanted to start a family soon and the dream of buying and running a business was very appealing to them. In the course of our conversation, I asked David whether he and his wife had any savings, to which he replied, “No.” As you can imagine, skiing is a highly seasonal sport. In the summer months the business dries up, revenue generation is uneven, creating unbalanced cash flow for the business and its owner. I expressed this concern to David, given his personal financial situation and the fact that his wife was planning on staying home and not working. The combination of the highly seasonal nature of the store, coupled with David’s limited savings and his wife’s desire to start a family, all led me to recommend to David that he was not ready to purchase the business. I advised him not to buy the store as I was concerned that he may be in way over his head. About a year later David called me. He mentioned that he had bought the store and needed a business plan that would support his application for a short-term loan to help finance operating expenses and bridge the seasonal cash flow shortfall the business had encountered. When I asked David how he financed the purchase of the store, he told me that he took nearly $50,000 out of his personal line of credit to buy the inventory and was leasing the retail space from the previous owner, who still owned the physical building. Needless to say, I grew concerned. I asked David what interest rate he was paying on the line of credit. He replied, “9.5%.” At this point, it became clear to me that David committed the mortal sin of blending his personal finances with those of his business. He took out a highly expensive line of credit to purchase a highly seasonal business he could not afford to buy with fixed expenses he could not afford to pay. By maxing out his personal line of credit, David had sunk his credit score to levels that, unfortunately, made him ineligible, as a business owner, for the majority of business loans. As I was speaking to David and explaining to him my view of the situation, I could feel his heart sink. I advised him to run a credit report to see his own score: it had gone from nearly 740 to below 630. On top of that, he owed the bank $50,000 he borrowed from the line of credit at an annual rate of nearly 10%. The previous owner of the store had built up cash reserves to provide the business with liquidity during the low season. David did not have such savings. Ultimately, he sold the business, repaying about $35,000 of his personal line of credit in the process, and taking a year to pay off the rest as he pursued a career in restaurant management. Other Articles From AllBusiness.com:
Why banks offer lines of creditLines of credit are a great tool for short-term needs, but should never be used to finance long-term cash shortfall in your personal life. For banks, lines of credit are just another way to earn interest, so naturally they make them available to you and hope you will take advantage of the easy money and don’t repay it any time soon. The longer your line of credit is being used, the more interest income the bank receives. I fully realize that there comes a time when, for personal reasons, you need to dip into your line of credit, sometimes even for long periods of time. This is what they were designed for; however, you should never fall into the temptation of using the funds from your personal line of credit to support your business—here’s why: Top reasons why your personal line of credit should be off limits to your business1. Your personal financial well-being must always come first. Never put your personal finances at jeopardy in order to keep your business going. A successful business will not require you to do this, whereas a failing business should be terminated and you should move on. 2. There are other sources of business funding. If your business requires financial assistance, there are appropriate tools such as loans and investor funding available to you. You can also leverage a business lines of credit, but never use personal lines of credit. 3. What happens if you fail? As in David’s story, you can be on the hook for repaying your personal line of credit if your business fails. 5 things you can do instead1. Start a business that requires little upfront cost. This can include consulting, marketing, SEO, web design, coaching, teaching, or affiliate marketing. There are tons of options. 2. Start or purchase a business where business assets can be used as collateral. Whether you are buying a dental clinic or starting a food truck (as examples), businesses that have fixed assets (which can be resold if the business goes under) tend to attract better financing options as lenders offer specialized loans for equipment, inventory, etc. 3. Make sure you have personal savings. You must ensure you have a personal financial safety net in case your business venture hits hard times and it is your only source of income. 4. Apply for business loans—not personal loans—to help finance your business operations. There are plenty of options available to small businesses that require operating, equipment, or cash shortfall loans. 5. Save and lend your savings to your business. Your personal line of credit does not belong to you—it’s a loan from a bank to your person; therefore, using it to finance your business is dangerous and unwise. Instead, take time to save some money, and if your business hits a snag, lend it from your person (as an individual) to your business. RELATED: 22 Mistakes Entrepreneurs Make When Pitching to Investors The post The #1 Business Mistake That Can Ruin an Entrepreneur's Personal Finances appeared first on AllBusiness.com. Click for more information about Guest Post. Copyright 2020 by AllBusiness.com. All rights reserved. The content and images contained in this RSS feed may only be used through an RSS reader and may not be reproduced on another website without the express written permission of the owner of AllBusiness.com.  |
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