If you’ve applied for financing for your home-based business—including the popular Paycheck Protection Program (PPP) loans recently made available as a result of the COVID crisis—you may have discovered an uncomfortable fact: your business entity may impact how and whether your business gets the loan it needs.
With PPP, businesses considered “self-employed” weren’t eligible to apply until a week after the first round of financing opened and guidance on how to qualify came out only a couple of days before the first round of funding was exhausted. Even after Congress replenished the coffers, business owners that reported their business income on Schedule C found it difficult to apply because they were required to use the net profit from their 2019 Schedule C. Never mind that the IRS has granted an extension for filing 2019 returns and many were unprepared.
When it comes to getting financing for your business, the business structure under which you operate may impact your ability to qualify for a loan.
First, let’s review the basics. While you may consider yourself “self-employed,” that’s not an official business structure. In fact, small businesses have several choices of how to organize their businesses, and the most popular business structures are:
- Sole Proprietorships
- Partnerships
- Corporations
- S Corporations
- Limited Liability Company (LLC)
A sole proprietorship is the least formal business entity. If you didn’t choose another business entity, then you’re a sole proprietor. While it’s easy to start a business this way, there is no legal separation between you and your business, or personal liability protection for you. In addition to greater legal liability, it also means that whenever you borrow for your business, you can be held personally responsible for the debt. Some lenders will not lend to businesses of this type, while others may lend based on a personal credit check of the owner.
While a small business can build business credit as a sole prop, it’s not ideal. It may be hard to get that type of business recognized by commercial credit reporting agencies such as Dun & Bradstreet, Equifax and Experian. At a minimum you’ll want to register your business name—your “trade name” or “doing business as”—with your state and obtain any necessary licenses before getting business credit in the name of your business.
The other business structures listed above—Partnerships, Corporations (including S Corps) and LLCs—can make it easier to establish business credit and to get financing in the name of the business. In addition, with a separate legal structure you may be able to move away from personal guarantees and truly separate your business and personal credit as your business matures.
Of course, lenders will still often consider other factors when evaluating financing applications including the following:
- Business and/or personal credit scores
- Time in business
- Revenues
If you’ve been operating your business without thought to a business structure, you may want to consider choosing a formal business structure that can help your business borrow in the future.
