If you’re a small business owner looking for financing, your personal financials will play a big role in your loan application. Lenders will look at your personal credit score and ask for a personal guarantee to back their capital. For them, your life isn’t entirely separate from the health of your business.
But what happens if that business has more than one owner?
Business loan applications with multiple owners aren’t all that different, but there are some important considerations for you to make — especially when it comes to whose financials those lenders will scrutinize.
Follow these steps before filling out that loan application if you’re one of several owners of a business in need of a loan.
1. The 20 percent rule.
If you have 20 percent or more ownership in your small business, chances are good that your financials will get examined by your lender. This 20 percent rule was started by the Small Business Administration, which requires a personal guarantee from all owners with at least 20 percent ownership applying for an SBA-backed loan. Personal guarantees let lenders recoup their funds if a borrower defaults, and this was the SBA’s way of protecting its lending partners from irresponsible business owners.
Many banks and lenders have followed suit, looking to the personal assets of all owners with 20 percent or more to act as collateral for their loans.
But it’s not just a matter of personal guarantees. Lenders also examine the credit scores of owners with 20 percent ownership or more when deciding whether to extend a loan offer or deliberating its terms.
In short, if you’re applying for a loan, check to see which owners have the most invested in your small business: they’ll have the biggest impact on your application.
2. Understand your application strength.
Next, make sure to discuss with the business owners whose credit scores and personal assets will matter to the lender.
- Is each owner’s credit score high enough? Or will one owner’s low credit score hurt your chances at qualifying for that loan you need? Talking about your personal credit scores could be an uncomfortable conversation — some people might be afraid of getting judged, receiving blame for a business issue, or feeling defensive of their own personal spending habits.
However, this talk needs to happen before you apply, because one subpar credit score can harm your entire application. And what’s more, your application might be hurt even if no single owner has low credit, but the total average isn’t very high. Lenders may worry about the compounded risk of several owners with less-than-ideal credit scores.
- Is each owner capable of signing a personal guarantee? And are they comfortable doing so? A personal guarantee might scare some away, since it puts your personal assets at risk in case you default on your business loan. If some owners with more than 20 percent ownership absolutely refuse to sign — or they’re not able to for some reason — then your loan application could be a non-starter.
If that’s the case, your first step should be to understand their concerns and try to address them. Personal guarantees are standard lending practice for small businesses without much collateral, as lenders need some way to protect their money, and they’re much less scary when spread across several owners. Try bringing up possibilities like a limited personal guarantee, which restricts the amount of the loan each owner is liable for, or personal guarantee insurance, which can cover up to 70 percent of your liability.
3. Change your ownership percentages.
While time-consuming and complicated, changing your business’s ownership percentages could help you qualify for the financing you need.
First, understand the policies of the lender you’re trying to work with. The SBA has a six month look-back policy, for example, which means you’ll have to adjust percentages far in advance. Other lenders might look at your articles of incorporation or tax forms. Still other alternative lenders might not follow the 20 percent rule at all, but instead only require that 70 percent or even 50 percent of the business’s total ownership be represented.
Next, work with an accountant and a lawyer. Each entity type has its own ownership rules, which can also vary by state, so you don’t want to make a mistake.
S-Corporations and C-Corporations require that owners buy shares from each other or the company, record the stock transfer, and file new incorporation paperwork with the state. For Limited Liability Corporations, you’ll have to swap stocks according to your LLC operating agreement, but you won’t necessarily need to update incorporation paperwork.
Don’t try this on your own, no matter how legally savvy you might be. Messing with the terms of ownership in your business’s articles of incorporation could have serious repercussions, so you’ll want to verify everything with experts.
If fear of a personal guarantee is holding back your application, it’s worth looking into alternatives like insurance or adjusted ownership percentages. Just make sure to work with legal and tax professionals.But if the problem is in your credit scores, a lender may be able to tell that you’ve fudged the numbers to cover up a deeper financial issue. It might be better to settle for the more expensive loan and up your business credit by managing that debt responsibly.