Starting a business requires start-up capital, and creditors need to be persuaded that they’re taking a worthwhile risk. By some estimates, less than 10 percent of new small businesses are approved for loans from banks or other commercial lenders. A poor personal credit history is a common stumbling block for entrepreneurs, but it’s not the only factor. Lenders and credit bureaus can perform more than 2,000 checks on a potential borrower and the business before making a loan determination.
On a more uplifting note, bad credit doesn’t mean you can’t succeed in business and it may make you more conscientious of your spending patterns moving forward. Remember it's never too late to start working on building good business credit.
1. Act like a legitimate business
Legally separate yourself from the business to shield personal assets. Forming a corporation or limited liability company (LLC) disentangles personal debts from business debts.
Other steps include:
- Obtain an EIN (the business equivalent of a Social Security number) from the IRS, along with a DUNS business credit profile number from Dun & Bradstreet
- Establish a physical address and separate phone line and bank accounts for the business, prepare a professional business plan, and acquire a business license
- Perhaps most important, maintain impeccable financial records, such as income and balance sheets, and tax return documents.
Creditors are looking for signs that a business is viable and profitable and getting all your ducks in a row suggests that you're a serious business person.
2. Get a handle on your personal credit
The right business structure won’t solve all of your problems, especially if you’re applying for larger loans. Business owners must stay on top of their personal credit scores even more than the average consumer to avoid higher interest and insurance rates. Most banks won’t deal with a business owner with a FICO score below 640 and some won’t look at you if you’re under 680. That includes loans backed by the U.S. Small Business Administration.
Get in the habit of pulling your free personal credit report from one of the three credit reporting agencies every few months at annualcreditreport.com and dispute any inaccuracies. This report is really a statement to lending institutions of your ability to honor your debts, but it also reflects your total amount of available credit, the length of time you’ve had a credit profile and the number of inquiries on your credit report.
While making timely payments and waiting for your personal credit to improve (which can take months), the types of loans available to your business may be limited to the “4 F’s: Founders, friends, family, and fools,” says David Gass, founder of Business Credit Services, Inc., a credit consulting firm headquartered in Wilmington, DE. Other options include peer-to-peer lending networks, equipment financing, or accounts receivable factoring, which don’t rely as heavily on personal credit history. If a business partner has superior personal credit, encourage him or her to sign for the loan. Some lenders, however, will run credit checks on all partners with at least a 15 percent ownership stake in the business, says Gass, who has written extensively about personal credit and small business loans.
3. Take advantage of trade credit
Trade credit, or business-to-business credit, is the single largest source of lending in the world and can be a valuable resource when furnishing an office or dealing with suppliers or vendors. Just be sure to pay it back on time and in full, encouraging the creditor to report a positive payment history to the business credit bureaus. While personal credit scores range from 300 to 850, business credit scores are on a scale of 0 to 100, with 75 or more considered an excellent rating.
If the business can operate over the Internet, payment processor PayPal doesn’t require a credit check and usually offers better transaction rates than high-risk merchant services.
After the business has built up some trade credit, you may approach a local lender for a small business loan. But don’t reach for the moon right out of the gate. Given the uncertain economic climate, Gass says, banks are applying more scrutiny to prior bankruptcies or tax liens, particularly on loans greater than $250,000. Over time, as you maintain a reliable payment history, your business credit rating will improve.
Margie Fishman has worked as a professional journalist for a dozen years, contributing to National Geographic, Newsday, ConsumerSearch.com and many other media outlets. In her down time, she enjoys bargain-hunting, dancing, pretending to be a fly on the wall, and playing with her hound dog, Ernie Pyle.