In today’s volatile economic environment, people are being more cautious when it comes to loans and borrowing money. When it comes to financing your business, it is necessary that you know what kind of loans are out there, and how either could affect your business and even your personal life. This article will focus on the two types of loans you may be considering: Business (commercial) and Personal (consumer) loans.
Here at Aztec Financial we strive to give small business the information they need in a nutshell. That is, we do away with all the legal mumbo-jumbo, and speak to you in a language you can understand.
It is important that you understand a few basic differences in consumer loans and business loans, and how LLC’s can help protect you when times are difficult.
Why you should not use personal loans to finance your business?
Consumer loans, also known as personal loans, include things like automobiles, home financing, and other personal loans. They may or may not require collateral in case the borrower cannot repay the amount owed.
Personal debt is generally not associated with your business, and shouldn’t be. It is not a sound financial move to use a personal loan to finance your business. If this happens, the debts incurred by the company can be considered as personal, which will not only affect your personal budget; but will also reduce your ability to borrow money for any future personal needs.
For example, if you have borrowed heavily for your business with personal loans, and your car decides to go to that big Junkyard in the sky, you may not be able to secure a loan to purchase another one.
Another thing to remember is that we are living in a society where if someone takes you to court over something company related, it could affect your personal assets. So, you never want to take out a consumer or personal loan to financially back your business.
Keep in mind that a personal/consumer loan is just as the name implies. It is for personal use. Your borrowing capacity is lowered as your debt to income ratio increases. If your business is having a rocky start, and you have personal loans backing it, you may not be able to obtain a home loan, or a car loan, because of the debts.
Business loans, as the name implies, belong to the business. In effect, what happens is, there is an invisible wall separating your personal finances and your business finances. In some cases, loans for your business can be arranged as an operating lease, making it a rental expense. A rental ex
pense is an operating expense, and therefore would not show on your balance sheet.
There is some confusion out there about what a Limited Liability company (LLC) or a Corporation is. Whether set up as a S-corp or a C-Corp, it is designed to protect business owners and their personal assets from the everyday risk of operating. The risks can include: Automobile Liability, Service Liability or Product Liability.
LLC’s and corporations are similar, yet different. The differences lay in the tax laws; but they are alike in the fact that they both have to be registered in the state they are physically located. They also provide legal protection from law suits and judgments filed by customers, but there are some rules to follow.
Here are a few:
- The company must avoid gross negligence.
- Professional service companies, such as doctors and lawyers, must add a ‘p’ to their LLC (LLCP).
- A series LLC, which can separate one asset from another.
- The business can stay intact if one member of the LLC leaves.
- Business and personal assets must be separated, such as cash and bank accounts.
Also remember that personal insurance does not cover business claims, and personal extended warranties can be canceled if the warranty holder determines the item is being used for business or commercial use.
The Corporate Veil
So what happens if you don’t follow the rules? Known in industry circles as ‘Piercing the corporate veil’, this means you have not followed the rules and maybe have allowed your personal and business world to combine. If you are sued, the courts may disregard the legal entity you have established and thereby allow the plaintiff to bring a legal action against your personal assets.
Applying a personal loan to your business may disqualify you for general liability protection. This means that the courts could view this as evidence that your business has not been managed or operated independently from your personal assets, and your personal assets would be included in the proceedings.
In this article, we have discussed several keynote topics which could make a world of difference in your business. We have defined what a consumer loan is. We have explained a business loan. We have compared the two types when it comes to business. We have also explored the benefits of an LLC, who could use one, and how it can protect your personal assets if things didn’t go well. We have also explored just a few of the rules which pertain to an LLC and corporation and what could go wrong if you didn’t follow them.
At Aztec we are specifically focused on business lending rather than consumer financing. Everything we do is designed to make sure that the contracts that you sign qualify as a business financing option so that we don’t get you in trouble with your CPA, your Attorney, or other government regulatory agency.