If you watch a few hours of TV, there’s a high probability of seeing an advertisement for a credit monitoring service. Some larger companies are spending hundreds of millions of dollars in venture capital money to become the most well-known brand in the credit score monitoring space. Personal finance upstart WalletHub is taking them on headfirst. When I asked the founder of WalletHub, Odysseas Papadimitriou, how he competes against much bigger companies, he answered, “by offering a better product.” He went on to explain that WalletHub supplements free 24/7 credit monitoring with daily credit score and report updates, which no other service offers.
As founder of WalletHub and an expert on personal credit, Odysseas Papadimitriou was the ideal person to have a conversation with about the personal finance implications of starting a business. The interview below is reconstructed based on my notes and not a verbatim transcription.
What are the risks of starting a business?
Starting a business carries many different risks. There are financial risks which go beyond potentially losing the money that you invest into the business. It’s very common to see the personal credit score of a person starting a business substantially go down during the year or two after launch. The lower credit score in turn may hinder their and their family’s ability to get a mortgage and own a home.
In addition to the business risks, starting a new business is very stressful and eats up every available minute. For these reasons, I strongly suggest that before starting your business, you sit down with your family to discuss whether it is a good decision and what implications it might have on personal financial decisions. Evaluate how it will impact your ability to buy a house, put kids through college, and save enough for a comfortable retirement. Basically, you need to consider what will happen to your family if the new business goes into bankruptcy.
What should a person do before starting a business?
Once you figure out how much money you are prepared to put at risk to start a business, you should look at ways to shield your assets if the business goes under. If you borrow money for your business, creditors will almost always demand that you personally guarantee the loan. This means that if the business goes under, you have to pay the debt.
Unfortunately, this sometimes forces people into personal bankruptcy. There are legal ways to shield your personal assets against bankruptcy. These may, but don’t always, include the following (as the laws vary by state): 1) putting funds into a retirement account; 2) putting funds into a 529 college savings plan; and 3) putting assets like a house in a spouse’s name.
With that being said, it’s worth noting that if your business goes under, your personal credit score is probably going to take a hit even if you don’t need to declare bankruptcy.
Anything else you should do before starting a business?
It is a great idea to set aside 3 to 9 months of expenses in cash before starting a business. This will help cover basic living expenses if things don’t work out.
If you are planning on buying a house or even a car, it is generally easier to get a loan before you start a business. A potentially higher credit score is not the only reason getting a loan will be easier. Banks and lenders like to see the consistent revenue stream of a W-2 versus the more volatile earnings of a small business owner. The best time to get a home equity line of credit or add more credit cards is before you start your business.
Odysseas Papadimitriou, CEO of CardHub and WalletHub, is a personal finance industry veteran and former Capital One senior director. He is widely recognized as an industry expert in personal finance and his views are regularly mentioned in leading publications, including The New York Times, The Wall Street Journal, the Associated Press, and CNN. Mr. Papadimitriou graduated Magna Cum Laude and received Honors for his Senior Thesis while obtaining a double major – a B.A. in Economics and a B.Sc. in Civil Engineering – from Brown University in Rhode Island. He holds an MBA from the Fuqua School of Business at Duke University.