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Why Your Startup Needs a Line of Credit


Because of the pandemic, many Americans are reconsidering their careers and even quitting their jobs to make themselves happier. Some of them will begin startups, while others may try more traditional, lower-risk ventures. Financial planner Bryce Sanders has advice for accounting professionals counseling small business owners.

Jul 19th 2021
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Many clients working 9 to 5 jobs dream of owning their own businesses. As their accountant, you realize their dreams are not always realistic. Regardless, many people do take that big step and start their own businesses. Some start small and grow to big operations. Other clients buy into a franchise. Some consult or set up a store on eBay. As their accountant, you know there’s a business opportunity there for you, too. One of your first conversations with your client should be about establishing a line of credit (LOC) for the business.

The Corporate Veil

Your client might not see the need to establish a second financial relationship with a bank. They might feel it’s a small-scale operation, that they will either have little or no expenses or that they can fund the operation themselves. Let's say you advise them to incorporate as an “S” or “C” corporation. They like the idea of limited liability and the protection of their personal assets, but they might not understand that merely incorporating doesn’t meet all the criteria for separation. They need a parallel financial structure.

The Rationale for the Line of Credit

Your client will go through a period when they are spending money but not bringing in revenue. Eventually, their revenue may ebb and flow. Suppliers won’t be sympathetic; they want to be paid on their terms.

Your client should contact the bank where they have their business checking account (they should set this up immediately after incorporation) and discuss opening up a modest line of credit, which the bank will treat as a commercial loan. There are several advantages:

  1. Credit will be more easily available. Your client can access funds as needed without returning to the bank to request a more structured loan, which takes time.
  2. The bank is likely to lend. Have a client set up the line of credit while their business is getting started rather than waiting until there is a cash crunch, as the bank might be hesitant to lend funds in that situation. This might require a personal guarantee, but there’s more potential reward than risk because the initial LOC is often small.
  3. It establishes creditworthiness. The LOC is designed for short-term borrowing, a way to smooth over any dips in revenue. A client can borrow when they need the cash and pay down the LOC once money comes into the business. Their good behavior builds up their credit history over time.

Other Steps Relating to Finance

Your client might need more advice on separating their business finances from their personal finances:

  1. Getting a business credit card. Even a small business will incur expenses. Your client might take prospects to lunch or purchase supplies at the store or stamps at the post office. They need a separate credit card in the business's name to separate these purchases from personal expenses.
  2. Getting business auto insurance. Your client will probably use their own car to drive to work lunches or the office supply store. What if they got into an accident on the way? Their standard auto insurance policy likely won't cover them for accidents that occur while using their personal car for business. They should buy a policy through their insurance agent providing this protection.
  3. Reimbursing business expenses. If your client uses a personal car for business travel, they can be reimbursed based on the distance traveled. Currently, it’s 56 cents per mile, which can add up. Your client needs to keep records of out-of-pocket expenses they claim from the business. This might be settled up monthly and paid by check.
  4. Lending money to the business. If there comes a time when your client needs to loan money to their business, doing so can’t be as simple as moving money or cash between accounts. There needs to be a paper trail, such as a simple letter explaining the amount of the loan and other details, even if your client is just writing to themselves.

The separation of business finances from personal finances is critical in protecting the client from personal liability. You file taxes for both the business and personal entities, and there needs to be an obvious separation of each set of finances. It’s a concept accountants understand, clients less so.

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