When Richard Branson started Virgin Records (now the Virgin
Group conglomerate), he did what most entrepreneurs do: He used his
personal savings, borrowed from relatives and patched together
enough funding to pay his bills during the difficult months. He had
many of the characteristics of successful entrepreneurs, but what
he did not have was excellent credit.
Many entrepreneurs do not have good credit. Some start a
business because they were laid off and don't have many
alternatives. Some start a business when opportunity strikes,
rather than when their personal financial situation is in good
condition. Some go through divorces and personal bankruptcies that
can ruin their credit.
If you are starting a business and have a poor (or nonexistent)
credit history, here are a few tips that should help:
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1. Forget big banks as sources of funding. In the past,
obtaining bank financing was based on the four Cs of credit: credit
history, cash flows, collateral and character. Today, this is no
longer true for most large, well-known financial institutions. They
care little about three of the four Cs-and instead tend to focus
purely on credit history in making lending decisions to
small-business applicants. This is because consolidation in the
banking industry has driven banks to automate their credit decision
processes and minimize the labor involved in getting to know credit
applicants face to face. If you have a great business idea but poor
credit history (such as a credit score below 650), you will not get
any money from banks. Even if you have a great business idea, a
strong character and relevant work experience, you are not likely
to get any money from big banks if your credit score is not above
the 600 to 650 range.
There is one notable exception to this rule: home equity loans.
If you are willing to secure your business loan with personal
equity in your home, you will have plenty of options even if you
have poor credit. But be very careful about relying on home equity
loans too early in the life cycle of your business. Cash flows for
startups are notoriously difficult to forecast.
2. Differentiate your personal credit from your business
credit. While large banks focus on your personal credit score,
smaller community lenders and business-friendly banks will focus on
a combination of your personal credit score, business credit score
and other factors associated with the viability of your
business.
Your personal credit score is determined by several factors,
including the outstanding debt balance on personal credit cards,
the number of open lines of credit accounts, bill payment history
and late payment history. Your business credit score is determined
by similar factors but is linked to the tax ID for your business,
not your Social Security number. This important difference can help
you get your business off the ground.
If your personal credit score is damaged, you should seriously
consider getting a separate tax ID number for your business as soon
as possible-whether you are incorporated or not. If you do not want
to spend the money to incorporate your business, you can still get
a tax ID number from the IRS even if your business is a sole
proprietorship, an LLC or a partnership. Talk to your CPA for
information on how to do this. It's very simple to complete the
relevant form (form SS-4) and send it to the IRS. You can apply
online at the IRS site.
In addition to getting a tax ID number, it is important to
ensure that your business is distinct from your personal identity.
You should consider getting a separate business address (not a post
office box), a separate bank account, an official corporate name
registered with local authorities and a separate telephone listing.
While these administrative chores might seem minor, they are
critical in distinguishing you from your business.
3. Build your business's credit score. Once you have
a tax ID number and a legal identity for your business, you can
start building your business's credit and establishing a means
to qualify for trade and credit lines from suppliers and sources of
capital.
A growing number of data companies currently track business
credit. For example, Equifax has recently developed the Small
Business Financial Exchange which provides participating banks with
a business credit report. (Click here for a sample.) This report contains
information on your business's performance on open lines of
credit, including credit cards, installment loans and even loans
between relatives, friends and business associates that are
reported to Equifax. If you are able to keep these loans on track
by making your payments on time, you can establish a strong credit
rating for your business.
There are several other data companies that collect financial
information on your business. D&B's PAYDEX score is among the most famous.
This score allows your suppliers to know the likelihood that you
will be delinquent on a payment. Specifically, the score measures
the extent to which payments to your existing vendors have been
made on time over the past 12 months. However, keep in mind that
most small vendors do not report to D&B. To maximize the
likelihood that your business's PAYDEX score is high (more than
70 out of 100), you should focus on paying large vendors who are
likely to submit information to D&B.
If you do not have strong personal credit, you should pay
special attention to ensuring that you build a good business credit
history with companies like Equifax and D&B.
Asheesh Advani is president of CircleLending, a
loan administration company that facilitates personal loans,
small-business loans, and mortgages. He and his company have
written the Small Business Financing Guidefor startups and
have helped small businesses in more than 30 states launch and
finance their growth.
The opinions expressed in this column are
those of the author, not of Entrepreneur.com. All answers are
intended to be general in nature, without regard to specific
geographical areas or circumstances, and should only be relied upon
after consulting an appropriate expert, such as an attorney or
accountant.