Before I was an entrepreneur, I was a Business Banker for a large financial institution. Doing the job for years, I sat across from many business owners that focused so much on their businesses that the basic financially wise decisions were glossed over or not even thought about. One of the most common was the idea of building business credit.
Building business credit is a pivotal step for all startup businesses. This is the ultimate way to prove to lenders and suppliers that the business pays its bills on time. Usually, credit scores are reliable statistics that are used to predict credit risks. With the right credit, businesses are rated from 0 to 100, where 0 represents high risk and 100 represents low risk. For startup businesses, credits scores are often measured by factors such as over time trends, public record regency, demographics, financial balances and payment habits.
When building business credit, it is important for startups to separate personal credit history and business credit to minimize any negative events that one history may have over the other. There are many financial issues such as too many debts that may impact personal credit history but should not affect startup business credit. Establishing a clear separation line between the two histories enables entrepreneurs to thrive. Credit separation provides the protection of both business and personal assets.
According to statistics, 40% of startup businesses are often turned down by credits due to low credit scores. The following are ways that will take any business credit to the top:
Clean Personal Credit
I recently started a new LLC which would be an extension of an existing business. I went to a local bank to open a new business account. In the process of opening the account, the Banker told me that I was pre-approved for a business line of credit and a business credit card. The funny thing is I did not have an existing business account there. I only had a personal checking and savings account.
My understanding of business credit is that most banks will not lend to a business unless the principle owner has managed a business account at that bank for several years or if that particular business has been up and running for a few years.
The Banker told me that when opening the account, the system does what is called a “soft pull” on my personal credit. It doesn’t hurt my credit or show up as a credit inquiry but the system gathers basic information about my personal credit. Since I have good personal credit and have been a customer of the bank for years, they wanted to extend credit to the business, even though the business is brand new.
I turned down the offer since I had no plans to borrow with this particular business. But it did drive home the importance of maintaining personal credit in order to make the most of business borrowing opportunities.
Check your personal credit score and report and work towards cleaning your credit. Work towards paying down loans and credit cards. Then, monitor your score and work toward increasing it over 700. Then follow the steps below to make your business credit worthy.
Make the Business Official
My time in business finance was great. I was able to help very successful businesses as well as individuals just starting out. One of the common things I witnessed was entrepreneurs that had big aspirations for their businesses but running their business as a sole proprietorship.
Look, there is nothing wrong, really, with running a business as a sole prop. But, if you really expect the business to grow and expand, the sooner you make it official the better. Especially if you want to build business credit. The issue is that sole prop businesses usually operate under the owner’s social security number and a DBA (doing business as). Well, what happens when your little side business begins to grow and you need other things like employees, protection against lawsuits, and loans?
I’ll tell you what happens, you will have to reestablish the business. Possibly as an LLC, S or C corp. Congratulations! Here’s the thing; in the eyes of lenders, this is a new business with no history. Even though you have been making money from the business for years, many banks will consider your personal income and credit more than the business. This is one of the reason, many entrepreneurs are frustrated by lending institutions.
General business partnerships and sole proprietorships do not give startups the benefit of separating business and personal credit histories because both histories belong to the same individual. However, business incorporations or LLCs makes it legally acceptable to separate the business from its owner.
Federal Tax Identification Number and Business Bank Account
This is a no-brainer but I used to see it all of the time; businesses running from a personal or paypal account. This seems like a good idea at first. But what happens if you get audited? You’ll have to find some way to go through years of bank statements to separate personal and business income and expenses. Or, you can pay an accountant to do it which will also cost you a fortune.
Business financial transactions should always be done in a separate account. This will ensure that all the transactions are dated and the debt card bill number is always maintained for future reference.
Often referred to as EIN, a federal tax identification number usually secures a startup by ensuring that it complies with IRS tax requirements and vendors pay-off services. Getting an EIN is super simple and you can get it for free by going to IRS.gov. This is like the social security number of the business. This is the number that will be used by banks and lenders to make credit decisions.
Business Secured Card or Line
Some banks (but not many) offer secured credit cards and secured credit lines. A secured line is when you place your own money into an account as collateral. The bank then extends a line of credit to you in for the same amount or a fraction of that amount.
When you think about it, paying to use your own money doesn’t make sense. But that is short term thinking, my friend. The goal is building a strong credit history so that in the case of funding needs, you can find a lender that will loan you the capital you need.
There are a few things that you want in a good business secured card. First, you want the card to be able to unsecure after a period of on time payments. Some cards will increase your credit line and add reward points to the card as an incentive to continue to use the card once the business has built credit.
Another feature to look for is a card that has a low APR so that you are not paying a ton of cash on interest rates. If you’re not able to find a low APR, pay off the entire balance each month before the interest kicks in.
Establish Good Trade Lines with Vendors
Vendors and suppliers could make or break a startup business credit line. This is because suppliers are always allowed to report to a business credit bureau in the business owner’s favor. Making early payments will certainly help businesses to acquire good credit scores. Also, long credit histories weigh favorably. Therefore, establishing credit relationships early is significant.
Building business credit for startups entails more than keeping clean records and borrowing from reputable lenders. Good credit practices do not only account for lower purchase interests but also accounts for a good level of trust worthiness and responsibility. This will attract customers to many startups in the long run and position new businesses favorably among vendors. It also reduces the number of times that a business should prepay for products and services. More so, it encourages better rates from both vendors and suppliers.
This should get you started on building credit for your business so that you have the option of borrowing if you need capital. Any questions? Ask them in the comments.