It is common knowledge that the business entity and individuals representing the business are two different entities; their personal actions do not affect the running of the business. Similarly, the business credit scores and personal credit scores are different, right from the way they are computed to the way the scores are being represented.
Therefore, it is frequently assumed that personal credit scores do not have a bearing over business loans.
However, it may not be the true in certain cases. We bring you more on how and when your personal credit score can have an impact on business loans.
Importance of Credit Score
Today, credit score has assumed a lot of importance and it is one of the primary ways a traditional lender can assess the creditworthiness of any borrower. Of course, there are modern fintech lenders who go beyond the credit scores, even if the past behavior of the borrower towards credit is not responsible.
Personal credit scores are assigned by any of the four credit bureaus in India and are represented by numbers in the range of 300-900 with higher scores indicating better credit scores. On the other hand, business credit scoring can be done by these credit bureaus and also by credit rating organisations like CRISIL, CARE, ICRA, etc. The method and representation of credit scoring of business credit scores varies with each credit rating or the credit bureaus.
Personal Credit Score and Setting up a Business
Every business is started by a person or a group of people and then is built on from there. In legal sense, the founders or owners of the business are separate from the business in certain forms.
However, when the company is at its nascence and is devoid of any business credit like loans and borrowings to be judged on, then the personal credit score of the owners/ founders is what the lenders can rely on to make the decision of approving or rejecting credit.
There may also be the case when the company has been in operations, but the lenders do not find enough information to base their decision on. Then, the lenders may like to draw some insights from the personal credit score of the founders/ owners.
You may have a banking relation with a particular bank, and you may decide to apply for a loan elsewhere due to some reasons. Though there may be bank statements and the company financials in place to help the lender make their decision, they may want to look at the personal credit scores too before making the final decision.
These are some of the instances when your personal credit score may assume importance when you apply for a business loan.
Forms Of Business that Determine If Your Personal Credit Score Is Important
When a business is incorporated, it can take different forms depending upon its structure. Each of these forms have a bearing on if your personal score will be considered while applying for a business loan.
Let us look into some important forms of business here
Sole Proprietorship: As the name suggests, the sole proprietor is the heart and soul of this form of business. As it is difficult to draw a distinction between the two, personal credit score of the proprietor or the owner is what matters when a business loan is being applied. Even by law, the sole proprietor is responsible for his acts performed in the capacity of a business owner.
Partnership Concerns: A partnership concern is only an extension of the sole proprietorship concern. Though certain forms of partnership like Limited Liability Partnership makes the owner responsible for only certain types of debt, it is unlikely that lenders would not scrutinize the personal credit score of the founders or owners while applying for a business loan.
Private or Public Limited Companies: These are evolved forms of businesses with larger scale of operations than a partnership or sole proprietorship and have a separate legal standing. Hence, the businesses may have their own credit score depending upon their dealing with debt in the past and their current financial position. In case of these companies, the personal credit score of the founders or key personnel of the company will not have much influence over approval or rejection of business loans.
Still there may be times when the personal scores may be considered just as supplementary information.
Forms Of Credit That Determine If Your Personal Credit Score Is Important
The type of credit that a business applies to can also determine if the personal credit score of the business owners is important for the decision making.
Short-Term and Long-Term Loans: Short-term loans are riskier lending for the banks, hence personal credit score of the owner may form a deciding factor of loan approval. The same applies for long-term loans as well which are not backed by a collateral. If the bank/ lender does not have enough information or business credit score to rely upon, any form of business loan may be impacted by the personal credit score.
Equipment Financing: If the credit is towards equipment financing, then there are chances that the personal credit score of the owners may not be looked into, as the credit is backed by the collateral of the equipment purchased out of that fund.
Invoice Factoring: Invoice Factoring is another type of loan which is obtained against the collateral of accounts receivable. As there is a collateral present here, other parts of the business including the personal credit scores of the owners may not matter much.
No matter what is the kind of business concern you run or the kind of credit that you are looking to avail, having a good personal credit score would always help you as a founder or owner of a business concern, as the lenders may find comfort in knowing that as founders you lead by example of being responsible towards credit.