Business Debt

Investing your own money into a business is not necessarily bad. Mixing business and personal funds when paying bills or taking on debt is. This is a far too common situation with self-employed contractors and sole proprietors of small businesses. Even if you’re a business entity of one, there should be separation between church and state, or business and personal finances, as it were.

 

To better understand this, make a list of all your current debts. Before taking out the debt snowball calculator to start paying them off, go down the list and mark which of them are business debts. If you’ve been mixing your money, this exercise will become frustrating rather quickly. So get up to speed first.

 

Your business structure could be too personal

 

Setting up as a sole proprietor or DBA (Doing Business As) and signing loan agreements with your personal signature makes your debt personal. Legally, if the bank lends money to an individual, that person is responsible for repayment. If you form a corporation or LLC, you can borrow money as a business entity. That makes the company responsible for the debt.

 

This applies to credit cards also. A common misconception that many small business owners have is that dedicating one credit card strictly to business expenses will make that card a business credit card. Ask the IRS how they feel about that. An auditor can, and most likely will, deny any deductions that you can only back up with receipts from a personal credit card. 

 

Look at this through the lens of risk and potential loss. Who is responsible if you default on the loan or fail to pay your credit card bill? Will the collection agencies come after you personally or try to put a lien on company assets? If you don’t know the answer to this, ask your creditors. It’s important to understand this distinction.

 

Secured debt vs. unsecured debt

 

Debt that is secured with collateral is easy to distinguish as personal or business. The nature of the collateral tells you all you need to know. If you put up personal assets, even if the funds are meant for business purposes, you have a personal secured debt. If those assets were business assets, like equipment or property, the loan is a business debt.  

 

Unsecured debt is almost always personal. Lenders want to see a decent credit score, good payment history, and a steady income that will assure them they’ll get paid back. Businesses are too volatile for unsecured loans. There’s too much risk of closure, bankruptcy, or potential sale, so lenders insist on collateral of some kind when lending to businesses.    

 

Good debt vs. bad debt

 

Assets that depreciate after you buy them, like vehicles for instance, are considered “bad debt.” On a personal level, an auto loan can help build your credit history. A business can take a write-off for the depreciation of the asset. If you’re buying a second vehicle and don’t mind paying a little extra for commercial insurance coverage, you might want to consider this.

 

The other side of the equation is good debt. Education falls in this category because it’s considered an asset. It’s generally a personal debt to pay for college, but there’s no reason your company can’t reimburse you for tuition. Speak to your accountant about the benefits of going that route. 

 

Research debt liability and tax benefits

 

There is much more to be learned about debt liability and the drawbacks and benefits of attaching it to your business. Foremost among these is the tax benefits you might receive by carrying some business debt. Read up on this and speak to a financial professional about your options.

Originally posted 2021-09-03 21:59:17.