March 29, 2021 | Last Updated on: January 8, 2024
DISCLAIMER: This article was written in 2021 and has not been updated. For more up to date information on economic impacts to small business funding, please read this recent article The Definitive Guide to Getting a Business Loan with Biz2Credit
Most companies require some form of small business financing at some point. When you run a business and your personal credit is in good shape, you want to know if your shiny FICO score is going to help your company land some better terms and rates. So what are the benefits that business owners can expect from having good credit?
It may be surprising to know, but many business financing options are actually based at least in part on the owner’s personal credit score! Especially if the business is trying to work with a bank or other traditional financial company like a credit card provider, personal credit score can be a much bigger factor than you’d think in getting funding for your business.
So a business owner’s personal credit score, when it’s in good shape, can be a real asset for the company with all kinds of financing needs.
But before you take your hard-won 750+ FICO score to every lender in town (or online) looking for a business loan, it’s important to understand the full picture of how good credit affects a business’s finances.
Right away, it’s important to know that having ‘good credit’ doesn’t always mean the same thing in every case. There’s a difference between your personal credit score and the way that a lender might evaluate your business’s creditworthiness. While you’re probably familiar with the way the FICO score works, basically giving every lender an identical score to look at, a business’s credit score will be calculated differently by different lenders, and might even use the owner’s FICO as part of the calculation.
A business owner should always make a point to keep his or her personal credit completely separate from their business credit. Failure to do so ends up leaving the business owner personally liable for any business debts. Building one’s business credit entails revealing to lenders how trustworthy the business owner will be when it comes to repaying a loan.
A favorable business credit score enhances the entrepreneur’s chances of being approved for a loan. Strong credit can also result in lower insurance premiums, superior rates and lower fees, and reduced deposit requirements on new leases and services. A business owner with a good credit score also has a better chance of negotiating favorable deals with suppliers.
A good business credit score enhances value of a company. The better a business credit profile one can build, the more likely the company will be to lure in new investors. Anyone investing in a business will carefully scrutinize the entire business before anteing up any funds, so a positive profile and a solid reputation are paramount.
A business owner’s personal credit will come under scrutiny by lenders when a company applies for a small business loan. Maintenance of a solid personal credit profile is almost as essential as a good business credit rating in the eyes of lenders.
Lenders also will be looking at the debt-to-income ratio of a business to see if the company’s cash flow is favorable and if the income is consistent. The more income versus debt that a business can show, the better the creditworthiness of the business in the eyes of the lender.
A small business that is not yet well established might have more difficulty getting approved for a loan. Lenders do not like uncertainty, and a fledgling company has not been around long enough to establish its financial soundness or credibility. A business that’s been around for a while has been able to build up a financial history upon which a bank can inspect to ensure that approving the loan application is a worthy risk.
How long does a company need to be in business before beginning to establish more reliable credibility with potential lenders? At least a couple of years would be a good baseline. A bank is also likely to look at annual revenue and how much current debt a business is carrying and what collateral the business is backing that debt with. Be sure to submit all the information that has been requested. Incomplete loan applications and a lack of supporting documents are the most common reasons why banks reject business loans.
Lending standards can make the process of getting approval for a small business loan an arduous undertaking. It can be sort of a circular predicament: In order to get a small business off the ground, the company often will need a loan, but getting approved for a loan is a lot more difficult for a business that has not yet established itself or its financial stability.
The application process for a small business loan starts with proper preparation. A bank may start by questioning the need for the loan. The business owner should decide what type of loan is the best fit for the company. Getting a loan to launch a business is a tall task in a company’s first year because banks need to see cash flow as evidence that a borrower will be able to repay the loan on time.
Small businesses often rely on personal financing, business credit cards or crowdfunding in their first year as a means of helping them become established. Once a company has a business history and has forged some kind of a credit record, more financing possibilities should open up.
Business lines of credit, small business loans, term loans and invoice factoring are financing options that are more likely to be on the table for a company that has been in business for a year or two than they would be for a company just starting out.
Small business loans–while not easy to secure for new businesses–can be accessed from banks, online lenders or nonprofit microlenders. Compare annual percentage rates and terms before making a decision.
A government agency that provides support for entrepreneurs, the United States Small Business Administration (SBA) backs small business loans issued through their lending partners to help lower financing rates for business owners. The SBA also can help entrepreneurs to qualify for loans for working capital. The SBA has a loan program with the purpose of making access to capital more attainable to business owners. Featuring low down payments and interest rates that are below market rate, the SBA 504 Loan Program allows small and medium-sized businesses to invest in their facilities and expand their reach, giving them more stake in their community. The SBA 504 program was developed with the intent of aiding small businesses in the creation of wealth.
Working capital loans secured through the SBA usually mean a larger selection of loan sizes, repayment terms that are lengthier and interest rates that are not exorbitant. Other means of short-term funding options usually don’t offer annual percentage rates as low as SBA loans.
SBA loans require a lot of paperwork, with a considerable amount of applications to fill out. Approval also will depend heavily on the applicant’s business history and credit score. But if you are willing to deal with all the red tape that goes with applying for an SBA loan, the upside is markedly lower financing rates and generous lengths of time to repay the loan than is the case with other loan options.
The length of an SBA loan can range from between five and 25 years. Although loans backed by the SBA give small business owners more access to financing, those loans still are competitive.
According to 2016 data from the Small Business Association, SBA loans are most frequently approved for the following types of businesses:
A strong credit score opens many doors for a small business owner. If the owner of a company has good credit, the owner is considered by lenders to be a good risk, which exponentially will expand the chances for the entrepreneur to secure approval for a loan, and also to qualify for loan and financing options with lower rates and better terms.
What is considered a good credit score? A score of at least 700 is regarded as “good” on a scale of 300 to 850. That baseline varies from lender to lender. Some banks might consider a score in the high 600s to be the threshold of a good score.
A high credit score qualifies the borrower for more financing opportunities, and the rates for those options will be lower the better one’s credit score is. The cost of borrowing money is lower if the small business owner has a good credit rating. A business owner needs a good credit score to enhance his ability to hire more employees, secure funding to acquire a business, construct upgraded facilities or to secure funding for emergencies.
It’s important to know that good credit scores or bad credit scores are not the only things that a lender should look at when providing a business financing decision. A poor credit rating is not necessarily always the result of irresponsible actions. When a small business suffers a hit to its credit rating, but still needs an infusion of working capital, there are solutions to consider.
A business that is on amicable terms with its vendors could request an extra amount of time to pay its debts to those vendors. It is obviously more advisable to pay vendors early, which helps establish strong credit, but a solid relationship might lead to vendors being more understanding and more trusting about the idea of allowing the business an extension. A company in need of cash on hand could also ask vendors if it’s possible to pay off bills in installments.
Asking someone outside the business realm for a loan is another possible solution to covering short-term expenses without a lot of cash on hand. But borrowing money from family or friends is obviously a situation fraught with its own potential for negative consequences.
There are lending options that are available for companies that have bad credit. In addition to short-term online loans and invoice factoring, both discussed above, three other financing solutions for a borrower with weak credit are available. These include lines of credit, micro-lending services and merchant cash advances.
When a lender provides pre-approved funding with a maximum credit limit, that is known as a business line of credit. If the borrower is approved for this line of credit, funds can be accessed whenever they are needed until the established credit limit has been reached.
Because the borrower is only paying interest on the amount that he or she withdraws, a business line of credit can be advantageous for business owners who are uncertain of the amount of funding they will actually require, or when they might need it.
The drawback to a business line of credit is that the loan will be at a rate that might be considerably higher than other types of loans. How costly that actually would be is heavily dependent on the amount of funds the entrepreneur ends up using.
If a business owner needs to establish a favorable credit history, a business line of credit could help him or her do that.
A seasonal business might favor a line of credit because its cash flow tends to be less consistent from month to month. Manufacturers, service companies and contractors are other common candidates for lines of credit, which help a business owner meet his working capital needs or bonding requirements without enduring a new application process each time with the help of a revolving line of credit.
A bridge loan is a short-term form of funding that can close a gap that exists between the capital a business owner requires right now and a longer-term answer to financing. Sometimes, a business owner has to land a bridge loan in order to continue operating on a day to day basis and pay the bills while awaiting greater long-term capital that has not arrived yet. According to the U.S. Chamber of Commerce, bridge loans can be critical to a business that is in a cash-flow lull when it has yet to get the longer-term funding it is awaiting to pay expenses.
A small business might consider a bridge loan to keep the company solvent and able to pay its bills during a time when cash on hand is scarce but invoices that are outstanding are on their way to being paid off.
The need for working capital could be the impetus to apply for a bridge loan. Working capital is the difference between the current assets a company has, including cash and accounts payable, and its current liabilities, which would include bills that need to be paid, salaries and any debts. If a business has more present liabilities than current assets, the cash shortfall that could result might prompt a business owner to seek a bridge loan.
The conundrum of owners of a new business encountering trouble getting loan because they either have bad credit or they just have not yet established business credit is a confounding obstacle for many. Increasing your business credit score is key.
These steps can help the burgeoning entrepreneur build a strong credit history:
Each credit bureau — Equifax, Experian and Dun & Bradstreet (D&B) — calculates credit scores employing their own formulas. These are generally personal credit scores. But some of these burueaus also track and report business credit scores to lenders. Maintaining a close eye on all three enables the business owner to be covered no matter which credit bureau his or her vendors, potential customers or creditors is checking. A more comprehensive credit profile means more credibility.
Purchases that a company makes from third-party vendors can assist in building up business credit. If suppliers extend trade credit, this can allow the small business owner to pay several days or weeks after getting the inventory. An accounts-payable relationship like this one might include having a supplier report the company’s payments to a business credit bureau. Adhering to the terms of any sort of trade agreement one makes with suppliers should help enhance one’s business credit score. Keep in mind that a D&B Paydex score requires a minimum of three trade lines.
A strong history of paying creditors in a timely manner–or early, even, if possible–can go a long way in the assembly of a favorable credit score. Dun & Bradstreet will only give perfect scores to companies that pay early.
The longer a credit history, the better. Establish credit as soon as possible and one’s rating will benefit from the strategy. Just like with personal credit scores, how often credit is utilized also plays into shaping a credit score. Credit cards and lines of credit are perfectly acceptable to use, but stay away from approaching your credit limit with them. Maxing out a credit card is certainly not the kind of sign a business owner wants to show a credit bureau.
Usually, when making a loan decision, business lenders will look for loan payment history, or other similar transactions that your business is making with its suppliers or creditors. Just like on personal credit scores, monthly payments that show a consistent track record do the most to boost your credit in the eyes of lenders. A spotless payment record will go a long way to establishing your company’s business credit, and help you secure the types and amount of financing you want.
A loan is not always a detriment to the establishment of business credit. In fact, getting business financing and then proceeding to pay off those loans on time–or early–is a good way for a small business owner to elevate their credit score. Some lenders do not report your activity to credit bureaus, however. A borrower should make sure that he is financing with a lender that will report to credit bureaus when trying to build their business credit.
A traditional bank typically reports to credit bureaus and will conduct a hard inquiry as well when you apply for a loan. Bank loans or loans from credit unions are therefore the gold standard in terms of improving your business’s credit.
Many online small business lenders also report. However, according to Nerdwallet.com, business funding companies like Lighter Capital, SmartBiz, Fundbox and many merchant cash advance brokers or alternative lenders do not report payment history to the credit bureaus. However, when you have financing from one of these sources, you can still demonstrate to a future lender that you are making on-time payments by sharing your business bank account statements or payment receipts.
A business credit report is going to include all public records filed in the company’s name. So liens, bankruptcies and judgements against the business will stand out like a sore thumb and be a major red flag to credit bureaus. It’s strongly advised to avoid having any outstanding small business loans or taxes that have not been paid. Negative marks like this can be a detriment for years to come in the eyes of credit bureaus. If you want to qualify for higher loan amounts, maintaining a credit report that is clear of judgments, liens and bankruptcies is essential.
