Feminists once declared that ‘the personal is political’. In a somewhat similar (though unrelated!) vein, it is safe to say that when it comes to business, the personal credit is commercial.
In other words, an individual’s personal credit history has a definite bearing on their ability to secure credit for business purposes. This is especially the case with SMEs, whose owners don’t have ready access to capital and thus have to rely on financial institutions and lending agencies for funds.
Sole Proprietorship and Personal Credit: Pros and Cons
The majority of SMEs in India are sole proprietorships, where a business is seen as an extension of its owner, rather than as a distinct legal entity. There is no special paperwork required to set up a sole proprietorship, and revenue from the business is treated as a portion of the owner’s income.
It is therefore taxed as if it were the individual’s net income, at the same rates as an individual’s salary.’
While this simplifies the process of setting up and running an SME, it also means that company finances can’t be divorced from the owner’s personal financial or credit history. What this implies for Indian SME owners is that their personal credit profiles can become a liability, impinging on their chances of securing capital from financial institutions in order to bankroll their businesses. What affects your credit score in one sphere of your life, will determine your chances of scoring credit in another part of your life.’
As a sole proprietor, your business’s balance sheet is coexistent with the state of your personal finances. You’re therefore not required to publish an annual account statement outlining your business’s credit and debit activities for that financial year. The personal status that your credit situation enjoys means that you don’t have to get your account statements audited either.’
Also called ‘unlimited liability’, one of the dangers of credit financing and loan taking is that your personal bank account and assets can be frozen or seized should you fail to clear any debts incurred in the course of doing business. If your business goes bankrupt, for example, you yourself could go bankrupt as an individual.’
Avoiding Personal Credit Risks Given its limitations and liabilities, it is possible to avoid using personal credit to leverage business or ‘trade’ credit. For example, revenue-based funds (RBF) are an option.
RBFs are one way that small businesses can circumvent the personal credit route. If your business has good cash flow, you can utilize your company’s revenue stream to secure capital from a lender. This option functions something like EMIs (electronic monthly payments) do when an individual wishes to buy something in installments.’
Banks and other funding agencies are willing to front capital in exchange for a percentage of an SME’s gross monthly income. In this scenario, your business’s current cash flow can trump your negative personal credit history. There is no doubt that when it comes to personal credit, an excellent credit score can help SMEs access loans better than a low credit score would. Thankfully, there are a number of helpful alternatives to the ‘personal is commercial’ dilemma, and every SME owner would do well to explore them.