Ask John: Business Debt

A Small Business Owner’s Debt Bleeds Over Into His Personal Credit

Background

Meet Paul, a 38 year old small business owner who lives in Maryland. Paul operates a small convention business that caters to other small businesses. Each year Paul’s company organizes and manages approximately 15 conventions in the Washington, DC, area.

Paul, like many other small business owners, uses a small business credit card issued by a major credit card company to help finance business expenses. This is a smart way to use someone else’s money for FREE for a small period of time. Once Paul’s clients pay him, he uses the money to pay off the small business credit card so he doesn’t incur interest charges. This is normally a solid practice.

Paul’s Dilemma

Paul’s use of the small business credit card is fine right up until the point where his clients cannot pay him. And, this is exactly what has happened.

Paul got stiffed by one of his customers but the story is much worse than that. He has incurred over $35,000 in non-refundable expenses organizing a convention for this client who now isn’t going to pay. All of these charges were put on his company’s small business credit card and payment in full is due in less than one month.

As with many small business owners Paul was required to take on personal liability for many of his business debts. This means that if he defaults on his personally guaranteed business credit then the lender can report that on his personal credit reports. If this happens then it’s a disaster for Paul. The negative item will likely be reported on all three of his personal credit reports for a period no less than seven years. This will significantly lower his credit scores and seriously hamper his ability to get personal credit like mortgages, auto loans, student loans and credit cards at decent interest rates. It will also make it more likely that other small business lenders who review personal credit reports will either decline his applications or offer less than optimal interest rates and loan terms.

What could happen here is Paul’s small business debt will bleed over onto his personal credit reports. This is perfectly legal and, in fact, is exactly what his lenders want. They feel that if they can make Paul personally liable for his small business debts that he will go to any lengths to make his payments. And, they’re right. In fact, his credit card company has made it very clear that if he can’t come up with payment before the due date that they will report his delinquency to all three credit reporting agencies.

Paul’s Options

Paul has several options on how to address this situation. However, he needs to be aware of the consequences of each. They are:

• Take money out of personal or business reserves to pay off the business debt. This will be painful but it will keep Paul’s credit in good shape.
• Find out if the lender will take a minimum payment in lieu of the full amount. This will only work if the lender will accept the minimum payment and NOT consider the account past due.
• If the creditor will allow, convert the account from a transactional account to a revolving account. This will allow Paul to make a payment that is based on a small percentage of the outstanding balance and keep the account in good standing. Essentially he will have converted the account to a high limit credit card with a significant amount of the limit used up.
• Take out a cash advance against a revolving credit card and use it to pay off the small business card in full. Paul will have bought himself another 30-45 days to figure out how to address the debt and perhaps collect from the delinquent client.

The Best Course of Action

Unfortunately all of these options will sting a bit but at least they will provide some opportunity for a happy ending.

No business owner wants to pull money out of interest bearing accounts just to pay off a loan to cover a delinquent client. And if a lender is not willing to work with Paul on the minimum payment idea or an account conversion then his options quickly become limited.

And, taking out a very large cash advance against one of his credit cards will also have a negative impact to his credit scores but in this case the effect will only last until the debt has been paid off. That is certainly much less painful than suffering a delinquent mark on his credit report for seven years. This might be the best option since the impact is short term and completely under his control.

Summary

Paul absolutely must avoid his lender reporting the account as being past due. It will flat out sink his credit scores and he won’t be able to do anything about it. Any “deals” or arrangements Paul makes with his lender to make a minimum payment or convert the account should be done in writing on their company letterhead. This will give him an official record of the arrangement and make it easier to correct errant credit reporting should that ever occur.

The following is the exact text (minus names) of our exchange with Paul

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