Applying for a small business loan is stressful enough without the prospect of bad credit throwing a wrench into things. Without strong personal and business credit scores, you’ll probably get stuck with unfavorable terms — if you get a loan at all.
In fact, more than half of small business owners who apply for loans don’t get them, with poor credit scores among the main reasons, according to the Federal Reserve Bank of New York.Aspiring entrepreneurs should build business credit as soon as possible to improve their chances of getting favorable terms when they apply for a business loan, business credit card or a business line of credit.
Impact of Personal Credit on Business Loans
Before applying for a loan to start a small business, or for a startup business loan, check your personal credit score. It could — and likely will — play a big role in the type of loan you get.
Banks and other lenders view your personal credit score as a reflection of your ability to handle money and meet financial obligations. If you have a low score, lenders might think you lack basic money skills and will take that into consideration when you apply for business credit.
It doesn’t matter if your business is a success, pays its bills on time (see free accounting tools for small business) or has a perfect payment record when it comes to business credit cards. With a low personal credit score, you’ll likely run into problems getting a small business loan in the first place. Even if you’re approved, you might get less money than you requested and will probably get unfavorable business loan rates.
How Bad Credit Can Negatively Affect Business Operations
Those aren’t the only potential problems with a low personal credit score, either – especially if you are still establishing business credit.
Entrepreneurs who rely heavily on their personal credit history to operate, and have a low personal credit score, might have a hard time accessing the most basic services. Here are a few examples showing how bad credit can affect your business:
Property managers look at credit scores when deciding to rent out office, retail or industrial space. With a low score, you might have a hard time finding a space to operate.
Utility companies consider credit scores when deciding whether someone qualifies for electric, gas or water service.
Vendors might not extend credit for needed inventory or equipment if your personal credit score is low.
A low personal credit score will make it hard to qualify for a small business credit card, at least one without a low credit limit and various use restrictions.
These problems can prevent your business from prospering. The best way to avoid them is clean up your personal credit and start building business credit that will help you achieve a high business credit score.
Differences Between Personal and Business Credit Scores
Personal and business credit scores both seek to determine someone’s creditworthiness and ability to handle money, but that’s about all they have in common. Here are some primary differences between personal and business credit score:
Personal credit scores, or FICO (Fair Isaac Corporation) scores, are reported by the three main credit bureaus: TransUnion, Experian and Equifax. These scores range from 300 on the low end to 850 on the high end. Scores of 800 and higher are considered excellent. Those 670 or higher are considered good. Scores are based on your payment history (see also payroll software), credit utilization, length of credit history, credit mix and new credit.
Business credit scores are designed to gauge a business’ creditworthiness. Agencies that provide business credit scores include Experian, Equifax, FICO and Dun & Bradstreet. Each agency has its own scoring system: 1 to 100 for Experian Intelliscore Plus and Dun & Bradstreet Paydex; 101 to 662 for Equifax business risk scores; and zero to 330 for FICO SBSS. These scores typically gauge a business’ likelihood of serious delinquency, its business credit history, the time it takes to pay debt, as well as its size and age.
How Lenders View Credit Scores
There are several different options when getting a business loan, ranging from bank and U.S. Small Business Administration (SBA) loans to venture capital investments to alternative funding procurement options.
Banks tend to be pretty strict when it comes to credit scores. A Forbes article explains that personal credit plays a “critical” part in a bank’s willingness to extend credit: “Banks are not in the risk business and they want to know that you’re borrowing with the intent and ability to pay them back.” If you have a low credit score, banks might require you to put up considerable collateral to get favorable small business loan rates.
It’s also difficult to get SBA loans with a poor credit score, for the simple reason that so many small businesses are competing for these loans. A credit score of at least 680 is usually needed to qualify for an SBA loan. We must also stress that there are numerous small business grants for women entrepreneurs who need business funding in cities across the nation.
Private lenders and VC investors are usually more flexible about business credit scores because they’re more willing to take on risk. The terms on these types of loans will vary from one entity to the next. And on a separate note, if you need a valuable loan related advice to help your business grow, these are the business podcasts worth listening to.
Keep Your Business Credit Separate
Building business credit is important for any entrepreneur. So is keeping business credit separate from personal credit and expenses. Here are a few ways to do that:
Set up your business as a separate entity such as a sole proprietorship, LLC or corporation with a separate address and tax identification number.
Register your business with the credit bureaus and get a Data Universal Numbering System (DUNS) number from Dun & Bradstreet.
Establish a separate business checking account.
Get a business credit card that you use only for business purposes.
How to Improve Your Credit Score
If you have a poor credit score, don’t get discouraged. You can improve it by taking certain steps:
Keep your accounts open even if you don’t use them, particularly for older business credit cards. The longer your credit history, the better your score.
Monitor personal and business credit reports regularly to see if anything negative is on there that can be fixed or disputed.
Set up automated credit card payments so you won’t miss payments
Don’t use your credit cards so much that you hurt your credit utilization ratio.
No matter what, don't ignore your credit score. Just because you ignore it doesn't mean it won't matter.