According to the Federal Reserve Bank of New York, more than half of small business owners who apply for loans fail to obtain them. The primary reasons: poor business and personal credit scores, or the fact that owners have been mismatched with lenders.
I talk to hundreds of small business owners each month -- from tech entrepreneurs to pizza shop owners. Turns out, most people have a good understanding about personal credit, but few know how business credit works, or even that it exists. The credit-knowledge gap is preventing too many smart, hard-working business owners from accessing the funds they need to thrive.
Many of these folks turn to friends, family and personal loans to fund their business. You may have taken this route yourself, and I understand why. If you’re deeply passionate about your business idea, you’ve got to be willing to risk everything -- even relationships -- to see it through. Unfortunately, people exploring this option do not realize that there are simple and proven ways to get what they need for their business.
By taking steps to build a credit profile for your company, separate from your personal credit history, you may be able to access 10 to 100 times more credit than you could as a consumer. And you need this extra capacity. On average, a business owner uses at least 10 times as much credit as a consumer. It’s nearly impossible to run, let alone scale, a business using personal credit alone. What's more, building business credit is easy to do, but too few business owners realize its importance.
Besides the additional capital you can borrow, there are other reasons for separating your credit profiles:
- With a business lender, you’re contractually required to pay the loan back, whether through collateral or business profits. The clear expectations and deadlines set down force you to use the money wisely.
- If you don't separate the two and your business fails, you risk losing your personal savings or indebting yourself to someone you’re close to.
- If the business is ever sued, your personal assets could be at risk.
- Separate business credit makes it easier to identify business expense deductions for tax purposes.
- Separate business credit protects your personal credit scores. Many business owners who rely on personal credit to run their business wind up maxing-out their credit lines -- a big mistake.
So, you get it: Keep your business and personal credit separate. But how do you get started?
1. Establish your business as a separate legal entity.
This could be as a sole proprietor, LLC or S-Corp. Sit down with your tax advisor or financial planner to determine which legal entity fits your business and financial situation. Sites like LegalZoom and Rocket Lawyer can take care of the legwork. You just complete an online questionnaire and pay a small fee. The websites fill out the documents and file them with your state. You can receive your official formation documents in about seven to 10 days.
2. Set up a business checking account.
This keeps your business financials more organized and allows you to get a clear picture of where your money is going. It usually takes just 30 minutes to set up an account at your local bank.
Use the business account for all business-related expenses. When paying yourself, deposit the money into your personal checking account. Your business checking account also allows your business to use employee payments as tax deductions from income, while letting you show personal income for the purpose of loans, credit and taxes. Business lenders will want to see your bank statements to get a true picture of how you’re performing.
3. Build a business credit history.
Start by opening a business credit card and always paying on time. The business credit bureaus will add this positive payment history to the credit file dedicated just to your company. Unlike personal cards, you may be able to deduct interest from business credit cards. When applying for a business card, just be sure to verify that the card provider reports to business credit bureaus and not to personal ones.
One of the biggest mistakes new businesses owners make is relying on personal credit cards to fund operations. Not only do you take on liability, you can damage your personal credit. If you have a personal score of 800 and max out your cards, your score will drop below 700. A 100-point drop will definitely cause your odds of getting credit to tank. It’s that severe.
Along with getting a business credit card, you should also open credit lines with your vendors and suppliers. This is known as trade credit. It gives you extra time (net 15, 30, or 60 days) to pay for your supplies and services. Depending on what type of industry you’re in, you can open accounts with businesses like Office Depot, Staples, UPS, Home Depot, etc. These companies are usually willing to establish a small credit line for your business without reporting or checking on your personal credit information.
As you establish a consistent history of on-time or early payments with these suppliers, your business credit scores will improve. This will allow you to access even more credit with even better payment terms. It’s a snowball effect.
4. Monitor your business credit regularly.
After establishing healthy business credit, you’ll want to stay on top of it. According to the U.S. Small Business Administration, the credit score of 33 percent of businesses may decline over just a three-month period. That’s why your lenders and creditors reassess your company’s creditworthiness on an ongoing basis. If your credit deteriorates, terms can be adjusted or stopped altogether. Without notice, you could be forced to pay cash on delivery for your supplies in place of your normal 30 days payment cycle. Regular monitoring helps avoid these nasty surprises.
As a small business owner, you may feel like the odds are stacked against you. Building a strong business credit profile separate from your personal credit is an easy way to level the playing field. By taking a few simple -- and proven -- steps, you’ll access more financing from more sources, and at better rates. This is when things get fun. Your credit actually starts to open doors rather than causing them to slam in your face.
Credit is something you’ve got to stay on top of, but the payoff is huge: growing your business dream into a reality.