For the small business owner, trying to navigate the credit and lending world can feel like a vicious Catch-22. Most commercial banks and traditional lenders are reluctant to loosen their purse strings until you’ve proven yourself with a strong credit history. But, it’s difficult to develop that good record when no one will lend to you in the first place.
Many small business owners rely on the strength of their personal credit to fund their business. But when you use personal credit, your mortgage, auto loan, personal credit cards all affect your ability to qualify for a business loan (and for how much). Using business credit separates your personal activities from that of the business. Your business credit is dependent on your company’s payment history, assets, cash flow, and other financials. It doesn’t include your personal debts or other personal financial obligations.
A strong credit history is the foundation for success, as it can lower your interest rates and give you access to more capital when needed. To start building your business credit, here are the initial steps you should take:
1. Set up a business entity
There’s no such thing as a business loan or business credit for a sole proprietor. That’s a personal loan. In order to receive a business loan or investment, you’ve got to separate the business from the personal owners and this means setting up a legal business entity such as a corporation (C Corporation or S Corporation) or LLC. Your CPA can advise you on the best legal structure for your particular situation, as your choice in entity can have some pretty significant implications on your taxes.
2. Get a Tax ID Number (EIN)
Every business must have a tax ID number, just like each individual has a social security number. The Tax ID number (or EIN) is a nine-digit number assigned by the IRS to business entities operating in the U.S. You’ll use this number to open your business bank account and it’s the basis for building your business credit profile. You can apply for your business’ EIN online through the IRS site ¾ and don’t worry, it’s fast and simple.
3. Establish a business bank account
Your business needs at least one bank reference. Ideally, your bank account will be at least two years old if you need to apply for a loan (of course, there’s not much you can do to change this situation…other than apply for a business bank account as early into the life of your business as possible). More important than your account’s lifespan, your business bank account should show a cash flow that’s capable of taking on a business debt. Of course, the optimum average daily balance of your account will depend on your type of business and the amount of financing you’ll be seeking.
4. Get Listed with the Business Credit Bureaus
Dun & Bradstreet (D&B) is one of the main business credit bureaus and runs its own business credit score. D&B gives businesses a separate credit file number (known as a D&B or DUNS number) that rates your credit profile. Go to http://www.dnb.com to find out if your business is already listed and has a score. You can also begin the process by applying for a free DUNS number, once you’ve established your business entity and have your EIN. The number is how lenders will determine your business’ creditworthiness; most business credit card and lending companies will ask for your D&B number during the application process.
5. Establish business credit history
Check if your trade vendors are reporting your payment history to one of the major reporting companies, like D&B. Just like with your personal credit score, the more vendors that report a good payment history, the better your business credit will be. It’s common that small trade vendors won’t be reporting your payment history to D&B. In this case, you should compile a trade reference sheet with at least three trade references (include their name, contact information, and credit limits) to augment your official business credit report. In addition, you should open a business credit card (in the name of the business) and use it wisely ¾ meaning keep your balance low and always pay on time.
6. Maintain a good personal credit rating
When you’re a relatively new or small company, creditors are going to be looking at the personal credit of the person who owns the business (or any shareholders with more than 20% ownership of the company). In today’s lending environment, you should expect to be asked to sign a personal guarantee on any kind of loan or credit of the business (this isn’t always mandatory, but it has become common practice in the lending industry nowadays). As a result, anyone with a 20% share in the company should keep a close eye on their own credit rating.
The most important thing to remember is that you can’t build business credit overnight. Business owners should think about their business credit from day one. Even if you’re self-funded now, you never know what challenges or growth opportunities will develop down the road. Having access to credit can only help you adapt to changing conditions and position yourself for success.
**Original content written by Nellie Akalp for Mashable