What Happens When Partners' Credit Profiles Differ

Dear Your Business Credit,

My partner and I are looking into starting a small business. We need $20,000 to cover an essential machine for our business. We will be creating an LLC and setting everything up properly. My question is what is the best route to go when it comes to securing that loan for $20,000? Would it be a small business loan, and if so would we both have to be on the loan since we are both on the LLC ownership?

We were looking at the option of getting a small business credit card as well, and the same question would apply: Would we both have to be on the credit application? I'm asking this because we both have strong credit (700 plus), but only one of us has provable income for the past year. Please let me know what route would be best in your opinion as well any other suggestions you may have. Thank you!

- Chris

Dear Chris,

Before you take out a loan to purchase the machine, consider leasing it, suggests Guy Turner, principal of Hyde Park Venture Partners, an early-stage venture capital fund based in Chicago. "Leasing is a terrific option if you can get it," he says. "Generally, you should try to access resources as cost effectively as you can, and under a variable cost structure." That way, if you decide you need to tweak your original business model and move on to selling a new product or service, you won't be locked into owning an expensive albatross that sits in your garage.

If you do decide to lease, you probably will need to undergo a credit check, he says. However, leasing programs are likely to be a little less stringent about those checks than, say, a bank loan.

But let's say the equipment is not available on a lease. Then you will probably need to try one of the alternatives you mentioned. "Before investors are involved, entrepreneurs will have to look for every option they can," says Turner. "If that means putting it on a personal credit card, so be it."

Just be mindful of your ability to pay off the debt, he warns. "I never want to see someone extend themselves so much that they don't have a path out of it," he says. If, say, the business fails but you're able to get a job earning $100,000 a year quickly -- and you have no dependents -- a $20,000 loan would not be overwhelming. "That's something that can be worked off," he says. However, if you're earning $40,000 a year, it would be a different story.

As for applying for a loan, Stephen T. Furnari, a New York City attorney who often advises startups, says that if you get a business loan from a bank, typically the bank will want the loan to be in the name of the business.

"Usually it'll be the company, the LLC, that will primarily be on the hook," he explains. "The bank will make both parties guarantee the loan, probably 'jointly and severally,' which means that if one doesn't pay, the other is on the hook for the whole thing."

If you choose to get a business credit card instead, Furnari sees no reason why the partner with guaranteed income should not apply individually for the card. To make sure both parties share the risk of any credit card debt in the event the business does not work out, small business owners should include information about how debts are to be handled in their LLC agreement, shareholder agreement or partnership agreement, depending on how the business is structured. That way, if the card is in your name and the credit card issuer pursues you for the debt, you can legally go after your partner.

"If they have an agreement that both will be equally responsible for debts to the credit card company, then the partner who had the card would have a claim against his partner for half," he says.

None of us likes to think about circumstances like that, but it's smart to work out details like this now, so you can both proceed with the partnership confidently. You will both be sharing a lot of risk in starting a business, and it's important that neither partner feels like the arrangement is lopsided, which could fuel resentments.

Good luck -- and please check back in six months and let me know how your business is doing.