Oct 31, 2018 Walt Wojciechowski
Consider the following scenario: Two individuals recently established a business that they are operating as partners, and to do so, they needed an initial infusion of capital. They acquired those funds by applying for a loan with a regional bank that offered business financing backed by the Small Business Administration, providing evidence of their entrepreneurial wherewithal to the lender that included a reasonable business plan and their personal credit profiles, both of which were very good. All of this is perfectly reasonable and quite plausible. But after that initial loan, the likelihood of these owners receiving financing for other company needs solely on the strength of their individual credit drops considerably. And any loan they do qualify for with their own credit may not have an amenable term length or interest rate.
"Strong business credit is essential for every company owner to establish."
Lenders will begin wanting to see quantified analysis of the business's credit as an entity apart from its two founders - clear proof that the company is fiscally responsible in dealing with its own debt accounts. This is commonly represented as a business credit profile and score, which is what banks or other institutional lenders hope to see when they receive applications for equipment financing, operating capital or other essential expenses.
Understanding the ins and outs of business credit and learning how to establish it won't be an instantaneous process, but the value it will offer in the long run is well worth the time and effort. Let's delve right into the thick of this process:
How business credit scoring and reporting works
The essential purpose of a business credit score is no different than that of an individual's personal FICO score or one of its counterparts - measuring individual credit history, types of accounts opened, amounts owed, habits of timely repayment and so on. All of these factors are measured on a much broader scale for business credit, though, as Fundera pointed out. For example, one person's $10,000 debt is a much bigger red flag than an equivalent financial obligation for an entire company, provided the business in question has made reasonable efforts to start paying back that amount. But the failure to address debt by arranging to pay on time, or to use a great deal of available credit in short order, will be just as detrimental to a business as it is to the average individual.
Also, while two of the Big Three credit bureaus offer both personal and business credit scoring, the scoring rubric is much different: from 1 to 100 for businesses as opposed to the 300 to 850 range seen with individuals. A relatively small decline in a personal credit score, such as 20 points, could be near-catastrophic for a business, depending on what level such a drop was from: 90 to 70 would be less than optimal, but sustainable, while 60 to 40 would appear calamitous to a lender, and thus likely prevent a business who'd recently experienced such a decline from being approved for a desired loan.
Business credit profiles may include much more detail than is factored into a business credit score, as the bureaus can pull from records of companies being opened, purchasing or leasing property and paying various local, state and federal taxes. If this is the only information in an organization's credit file, the lack of data can be almost as problematic as having poor corporate credit, which is why creating a comprehensive and appealing profile is so important.
How to establish business credit: The early fundamentals
For startups, establishing a business credit profile and then building it up begins with the formal creation of the company as its own entity. To be rated by Dun & Bradstreet as well as the aforementioned major American credit bureaus (all except TransUnion, which does not rate businesses' credit), an organization must be registered as a sole proprietorship, corporation or limited liability corporation under the terms of U.S. federal law. But as D&B makes clear, only the latter two allow for a company's founder to entirely separate their personal and business credit scores, which is almost always a better option than having the two financial measurements irrevocably linked to each other.
This first step is followed up by registering for and receiving an employer identification number from the IRS, so that the new business can pay its taxes when that time comes. Next, owners should apply to the business credit bureaus to receive unique identifiers, which prospective lenders will be able to use to quickly find the corporation's profile, and finish up the basics by opening business checking and savings accounts with no connections to any of the owners' personal accounts. Segmenting and separating assets and information this way will be critical when applying for business financing in the future.
Building better business credit with more sensible practices
The firmest foundation of good business lies with the development of good relationships. This starts with companies developing bonds with their customers, of course, but for true success to be found, that principle of relationship building has to hold true across all aspects of commerce. The vendors and other partners that a business works with on a regular basis must also be a part of this practice. According to Nav, forging strong initial connections with these third parties will end up being the building blocks for managing critical situations in the future: Coming to agreements on supplier orders and paying them back on time creates the sort of trust that's necessary for times when a company needs an equipment shipment immediately and has to rely solely on the value of its word.
"Trust between businesses and their vendors is of the utmost importance when establishing business credit."
This isn't to say firms should only pay on time early on. Timely repayment has to be the norm so that occasional aberrations are viewed by all of a company's creditors as the exception, not the rule. But as long as business owners develop strong relationships with three to five well-established vendors - and ensure that all of those creditors report the completed payments to all of the business credit bureaus - Nav noted that this will be an entirely respectable credit profile for a business to have while it's still getting itself off of the ground somewhat.
Open a business credit card account - but be careful
Once a company has managed to add enough evidence of creating and repaying debt, the next step toward building a genuinely strong business credit profile is opening up a credit card in the firm's name. Ideally, owners should start with a single card, but depending on how some organizations are set up, it might be worthwhile to open more than one card, or to add a trusted managerial-level employee to the card account as an authorized user. If possible, search for a business credit card that offers discounts or rewards for certain expenses, as such perks can reap considerable dividends somewhere down the line.
Keeping business credit under control
After establishing a respectable business credit profile, owners must labor to preserve the strength of the fiscal reputation they've built up. Careful monitoring stands out as the key practice for accomplishing this goal, according to Credit Karma. Any mistakes, fraud or other discrepancies can do significant damage to a company's business credit profile if these errors aren't quickly discovered and promptly addressed - potentially by filing a dispute with the credit bureaus. Checking in on the state of the company's credit on a regular basis - weekly at the very least - helps owners maintain peace of mind about this complicated aspect of their corporate finances. Last but not least, Credit Karma recommended using the business credit card as a tool for managing cash flow. Because the interest rates and card agreements can be more favorable when using cards for business credit, using the card helps reduce cash output and may facilitate opportunities for significant capital savings.
Microbilt offers a full suite of tools for businesses seeking to more closely monitor and control their business credit profiles, including access to multiple records databases, verification platforms, trend analysis across multiple industries and much more. These offerings are fully compliant with the Fair Credit Reporting Act and all other relevant regulations. Contact us today to learn more!