What happens to your business assets if you declare personal bankruptcy? What kind of personal and/or business credit do banks expect to see if you apply for a business credit card versus a personal one? If you own a business and it goes down the tube, how will that impact your personal assets and finances?
These are questions that I am often asked when people learn that I have written or blogged for the past decade on topics of personal finance, credit cards, and small business loans. Naturally, these are also the kinds of topics that are always going to depend on a variety of individual circumstances and legal or financial situations. That’s why it may be important to consult legal and financial professionals such as an experienced bankruptcy attorney, tax planner, or certified financial advisor.
I do not have any of those legal credentials. Before investing in that kind of counseling, however, I may be able to help by sharing with you a general overview and understanding of how these issues often work. Knowing a little bit about the various ways that business and personal finances are related and how that can come into play in the event of a bankruptcy – or when you apply for credit cards or other loans – may be quite helpful.
Personal Bankruptcy and Credit Card Applications
When you apply for a business credit card, the card company will typically pull your personal credit report and use that in their evaluation process. They will be looking at the credit utilization ratio and for any red flags such as missed payments, defaults, or bankruptcies. Financial institutions may go further, too, if they discover a bankruptcy in your recent past. They may acquire copies of the court documents in relation to that bankruptcy to verify what requirements, liens, wage garnishments, etc. has been ordered in the judgment.
Many small business owners also personally guarantee the company's debt, meaning they secure loans with such things as inventory, equipment, building loans, and business credit cards with their personal credit and/or collateral assets. By doing so, they expose themselves to the potential downside if they are unable to meet their legal and financial obligations. All that depends on what type of a business you have.
In the wake of that kind of scenario, your personal credit can take a serious hit. If it involves bankruptcy, for instance, your credit may be harmed for as long as seven years or more. That can make it very difficult to get a business or personal credit card. In the event that you do wind up in that situation, however, you may want to look into getting an affordably priced and highly rated prepaid card or one of the regular credit cards specifically designed for people with bad credit who want to start rebuilding their credit profile.
Business Bankruptcy and Personal Credit
What if you use a strategy commonly employed by small business owners and let your home act as the collateral on a business line of credit or loan? Should you fail to repay those obligations the bank can – and definitely will – foreclose on your home. Foreclosure laws do differ from state to state, however, and so do bankruptcy laws. There are states that have so-called “homestead laws,” for example, that are intended to protect residents from losing their homes due to this kind of financial catastrophe.
Even if you live in one of the states that does offer this kind of legal shield, it may not be sufficient; there’s usually a cap put on how much protection you have. If you have oodles of valuable equity accumulated in your home, for example, business creditors may still be able to come after it to satisfy unpaid business debts. Keep in mind that homestead laws only apply to your principal residence, too, so if you have other real estate such as a rental property or a vacation home, it will not be covered under that kind of legislation.
Anyone who owns a business should therefore take preemptive steps to protect their personal assets. Contributors to this site have blogged on this topic, too, so take advantage of their insight and advice by reading up on topics such as what categories or versions of bankruptcy there are and what each of them entails. Before setting up your business you should also consult a qualified attorney to help guide these kinds of choices.
Applying for Business Credit Cards
If your business is in good financial shape and you are a sole proprietor (or the principals or executive officers of your legally incorporated company) with good personal credit, then a business credit card can be a helpful tool for you. The variety of business cards available to businesses is broad and diverse. Some will come with travel perks or travel rewards, while others will earn you extra bonus points on certain categories of purchases.
Before applying for one, however, take steps to ensure that you apply for the right card so you’re approved, otherwise you will get a “ding” on your credit file each time you apply for credit. Once you receive you’re business credit card, start building your business credit by completing such tasks like getting a DUNS number.
Also keep in mind that business credit cards are not subject to the rules and regulations of the recently passed federal CARD Act, which provides some great consumer protection for Americans. You may be subject to unexpected rate hikes, for example, or additional fees and charges that are now (thanks to the CARD Act) illegal on personal plastic.