The #1 Business Mistake That Can Ruin an Entrepreneur’s Personal Finances

financial crisis

By Alex Ormond

I have been wanting to write this post for a very long time. Out of hundreds of business owners—either current or prospective—that I speak to on a regular basis, nearly one-half tell me they are about to commit the mistake I discuss in this post without realizing how it can set back their personal finances. In fact, you might consider this post a public service announcement, because the ease of making this mistake, coupled with its long-term effect on your personal financial well-being, is shocking.

I am talking about using a personal line of credit to fund your business. On paper, this process does not sound catastrophic, dangerous, or worrisome. In fact, it sounds logical and easy.

The typical thought process individuals share with me is as follows: You are passionate about starting a business or maybe buying an existing one, you have a good credit history, and the bank has given you access to a line of credit. It is sitting there waiting to be used and you realize that it’s an easy way to fund your dream of entrepreneurship—be it buying computers, equipment, paying yourself a salary, or depending on how large your line of credit is, even buying a business. You can simply take the money out of your personal line of credit and transfer it to your business. Easy!

In reality, however, this simple transaction can decimate your personal financial well-being, cut off your personal access to credit, suck you into a whirlpool of high interest rates, and leave you with a subpar credit rating for years to come.

A cautionary tale

A few years ago, I met David (name changed) and his wife for coffee. David was interested in buying a ski equipment shop where he worked from its then current owner. Both David and his wife were in their early 30s, did not have kids, but wanted to start a family soon and the dream of buying and running a business was very appealing to them.

In the course of our conversation, I asked David whether he and his wife had any savings, to which he replied, “No.”

As you can imagine, skiing is a highly seasonal sport. In the summer months the business dries up, revenue generation is uneven, creating unbalanced cash flow for the business and its owner. I expressed this concern to David, given his personal financial situation and the fact that his wife was planning on staying home and not working.

The combination of the highly seasonal nature of the store, coupled with David’s limited savings and his wife’s desire to start a family, all led me to recommend to David that he was not ready to purchase the business. I advised him not to buy the store as I was concerned that he may be in way over his head.

About a year later David called me. He mentioned that he had bought the store and needed a business plan that would support his application for a short-term loan to help finance operating expenses and bridge the seasonal cash flow shortfall the business had encountered. When I asked David how he financed the purchase of the store, he told me that he took nearly $50,000 out of his personal line of credit to buy the inventory and was leasing the retail space from the previous owner, who still owned the physical building.

Needless to say, I grew concerned. I asked David what interest rate he was paying on the line of credit. He replied, “9.5%.” At this point, it became clear to me that David committed the mortal sin of blending his personal finances with those of his business. He took out a highly expensive line of credit to purchase a highly seasonal business he could not afford to buy with fixed expenses he could not afford to pay. By maxing out his personal line of credit, David had sunk his credit score to levels that, unfortunately, made him ineligible, as a business owner, for the majority of business loans.

As I was speaking to David and explaining to him my view of the situation, I could feel his heart sink. I advised him to run a credit report to see his own score: it had gone from nearly 740 to below 630. On top of that, he owed the bank $50,000 he borrowed from the line of credit at an annual rate of nearly 10%.

The previous owner of the store had built up cash reserves to provide the business with liquidity during the low season. David did not have such savings. Ultimately, he sold the business, repaying about $35,000 of his personal line of credit in the process, and taking a year to pay off the rest as he pursued a career in restaurant management.

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