Once upon a time there were two entrepreneurs, Shelia and Tom, who had an idea to sell widgets online. They put together a great business plan, and based on this, applied for and received a small business loan. In a few years, the business, Widgets International, was very successful; the original business loan was paid off.

Sales grew quickly and keeping up with demand meant leasing a warehouse, stocking inventory and hiring employees. To pay for it all, Sheila and Tom applied for and received a business line of credit. They also applied for several business credit cards online to float the debt during the course of business. In all cases, the business credit applications required the business Tax ID number and both of their personal Social Security Numbers.

Then the economic situation changed and sales plummeted. Widgets International managed to keep things afloat for awhile, cutting costs and laying off employees, but eventually, the whole business credit line was used up, and the credit limits on the business credit cards were maxed out. But the bills kept coming in: suppliers were still sending invoices to the company, the warehouse they had leased was demanding its money, and the business couldn’t meet their financial obligations. Tom and Sheila decided to cut their losses and close the business. The business filed for bankruptcy, and Tom and Sheila began to look for a new careers and opportunities.

6 months later, Sheila began receiving calls from collection agencies demanding payment for the defaulted business credit line and credit cards. When she explained they were business credit cards and lines of credit, the collection agency informed her she and Tom had personally guaranteed the debts and now both of them were on the hook for all of the past credit.

I hear about this situation all the time. and they always ask me – “Is this true? Is a small business owner personally responsible for business credit?” Well, it depends.

In Sheila and Tom’s case, the only way they could get a business line of credit (and also the credit cards) was to use personal credit to apply for the loans. The most important element to establishing business credit is finding lending institutions, credit card issuers and vendors that will establish credit without you giving a personal guarantee. A personal guarantee involves using your personal credit information to guarantee repayment of the debt incurred by the company. In other words, you are obligating yourself to be 100% responsible for the company’s debt.

The original small business loan received by Widgets International was based on a carefully prepared business plan, not personal credit. No personal guarantees were involved. Unfortunately, in their rush to obtain financing, Tom and Sheila used their personal credit to apply for online credit cards and got a quickie personal line of credit from the bank.

The double whammy? Since the debt is a business debt, even though Tom and Sheila are personally on the hook for these debts, the Fair Debt Collection Practices Act does not apply. The FDCPA is for consumer debt only. What this means is that legally, the collection agencies are not bound by restrictions set forth in that law. They can be nasty and abusing and do not have to provide debt validation.

Be careful when applying for business credit:

1. Don’t personally guarantee lines of credit or credit cards
2. Don’t operate as a sole proprietor. In order to establish business credit without a personal guarantee you must structure your company as a separate legal entity such as a corporation or limited liability company.
3. You must have an Employer Identification Number (EIN) also known as a Federal Tax Identification Number (Tax ID) for your company. The EIN is your permanent number and can be used immediately for most of your business needs, including opening a bank account, applying for business licenses and establishing a business credit file. Never use your social security number.
4. You should have at least one bank account, in the name of your company that can be used as a bank reference. The older the bank account, the better. Having a business checking account helps in establishing your company’s identity and reputation.

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