Since a start-up has not established a credit score, lenders rely on the credit history of the owner. Your personal credit score directly affects your ability to secure capital. “Studies show that many small business owners borrow personally to finance their business operations, further intertwining small business borrowing and owner personal credit.” (Brown) Management of personal credit is a mirror of how one will handle business credit. Brown also quotes, “According to Small Business Trends, the power of personal credit scores to predict small business loan repayment, the legal structure of many small businesses, and small business owners’ use of personal guarantees and personal borrowing to finance business operations, all link small business owners’ personal credit to their companies’ access to capital.” Capital, which is essential for starting, building, sustaining and expanding the business, often diminishes within the stages of growth and development consequently, causing major set-backs or even shut-downs. “Bootstrap” or self-funding, coupled with borrowing money from close sources like family and friends is often the entrepreneur’s first line of finances. (Wasserman, 2012, pg. 26) Angel investors are often sought because they seek no return on the investment. It is a gift, but this line of financing can only go so far without a strategic plan. Credit is imperative in business growth and development.
The financial crisis that occurred when the housing bubble burst in 2008, changed the face of liberal lending. This financial “perfect storm” created market instability – “a dramatic change in the ability to create new lines of credit, which dried up the flow of money and slowed new economic growth and the buying and selling of assets.” (Guina, 2016) Who was left in the struggling to gain footing in the aftermath of the storm- banks, businesses, you and me. “Millions of small businesses had their lines of credit reduced or revoked, with many loans being called in before their due dates. In the first six months of 2009, 38 percent of small businesses reported a decrease in their lines of credit or credit card limits, according to the National Small Business Association.” (Fay) It shook the core of our economy and drove the US into a recession. What that meant for the business owners was strict credit scrutiny. “Startup businesses face credit problems as lender closely examine both personal and business finances prior to approving loans. Startup business owners must provide a financially sound business plan and have a clean credit history prior to applying for business loans. Lenders will look at the owner’s debt to credit ratio, credit score and past credit history before a loan approval.” (Zoldak)
Experian reports that credit scores range from 300-850, where 300-549 is considered as very poor, anything above 800 is excellent. An average good score is in the high 600-750 range. Everyone should check their credit report annually from https://www.annualcreditreport.com/index.action . This free annual report compiles data from the three main credit reporting agencies-Equifax, Experian, and Transunion. This report not only shows your credit standing, but it allows you to follow your progress and gives you early detection of information reported incorrectly.
A decline in credit worthiness morphs from many life events. The average person’s goal in life is not to have bad credit. Something happens that changes the one’s ability to maintain their lifestyle. Canadian financial consultants, Ginsberg Gingras suggests these causes of financial problems:
- Loss of a job
- Decreased income
- Separation or divorce
- Work-related accident
- Student debts
- Lack of familiarity with the consequences of using credit
- Victim of fraud
- Gambling problems
- Drug Addiction
Any one or combination of these factors will cause a personal credit score to plummet. All create the inability to pay personal debt. Personal debt management speaks to how a person will manage business debt. You are the same person. A bankruptcy, unpaid taxes or a felony can also contribute to the downward spiral of a life event. Your ability to recover will give an advantage in starting to rebuild personal credit and establishing business credit.
One may think that a life event like job loss is a great time to start a business, but is it? JD Roth asks, “Can your emergency fund last until your business is profitable?” Your financial responsibilities are not suspended. Your credit must stay worthy through the transitions. Launching your new business should be planned not forced. Roth also suggests, “While you are searching for your next job, I think it would be a great idea to devote some of your free time to further developing your ideas for a business. Then once you’ve obtained your next job, re-established yourself financially, built-up excess savings, and determined the proper time to enter the market, you can begin to implement the idea with confidence and a much faster road to success.” The road to incredible success is obtainable after termination. Steve Jobs, Oprah Winfrey, Walt Disney, Mark Cuban and Thomas Edison just to name a few are testaments to this truth.
David Balovich, in his article What Causes Businesses To Fail?shows that industry consultants give five reasons why businesses fail: loss of revenue, management/operational issues, lack of capital, economic conditions and credit/debt issues. For credit issues he states, “Many businesses for too long have relied on access to easy credit in the forms of lines of credit, loans and home equity lines of credit to finance their businesses. Small to mid-size businesses are now struggling as a result of tighter lending, high-rate credit cards, reduced lines of credit and maturing loans.” All of these issues flow back to housing crisis. He further explained, “…from the credit professionals’ perspective the two primary reasons a business fails are poor management and economic conditions. Poor managerial experience: including not following the business plan, weak internal controls, poor execution, hiring the wrong people, poor delegation skills, poor communication skills, ineffective time management.” Economic conditions are usually something that is beyond managements’ control. Good management practices, however, can permit management to respond to those opportunities and challenges that the economy, good or bad, is constantly presenting.”
He concludes with, “The good news about managerial shortcomings is that management has control over them and they can be corrected. The bad news is that management will sometime overlook these shortcomings and find fault elsewhere never admitting that they were to blame for the failure of the business.”
As we have seen, personal and business issues emerge in many forms from life events to lack of business planning. But credit worthiness can be restored. There are alternative funding strategies when your personal credit is damaged. Maggie McCormick offers several ways in her article, Starting a Business With Bad Personal Credit.
- Set up your business as a separate legal entity. Register with your local government, sign up for a Federal Employer Identification Number and register for a Duns & Bradstreet number [provides business credit history]. This allows you to start creating business credit.
- Bootstrap your business using your own funds. Do what you can to reduce your start-up costs. Learn to do things on your own so that you don’t have to pay someone else to do it. Use your own money to pay for the things that you need.
- Purchase equipment and supplies on store credit from a company that reports your credit activity to the bureaus. Since the goods that you buy secure the loan, this is easier to get then other types of small business funding.
- Apply for a credit card. At this point, you may have a bit of positive credit history that allows you to get a business credit card with a small limit. If you cannot, then put down a deposit on a secured business credit card so that you can start to build credit.
- Use PayPal as a payment processor. A traditional merchant account will look at your credit score when making a decision of whether to approve you or not. PayPal allows you to accept credit cards from anywhere you have an Internet connection without a credit check.
- Build a client base to start generating income. When you have income coming in, lenders will view you favorably.
In his article What Causes Businesses To Fail?, CM Brown believes that there are other factors that contribute to credit worthiness for a business such as bank deposits, credit card sales and credit partners.
- Bank deposits – A business with regular bank deposits can put its cash flow to work with revenue-based loans. This program is based on the deposits going into the business bank account on a monthly basis. Typically, a business can obtain a business loan equal to 10% of its annual gross deposits regardless of having bad credit. Another benefit of this program is the time it takes to get funded, which is approximately seven business days. Keep in mind the loan term can be as long as 18 months with this program, with rates slightly higher than a traditional bank rate. It requires no collateral, financials or tax returns. Repayments are made in small increments every day via ACH from the business bank account.
- Credit card sales – This type of funding program, known as a merchant cash advance, provides businesses with upfront cash in exchange for a portion of future credit card sales. For businesses that have regular monthly credit card sales but struggle with bad personal credit, a merchant cash advance may be a viable option. However, be very selective on what merchant cash advance provider you select. Some providers can cost as high as 38% while others can be as low as 12%. In addition, when it comes to repayment, the majority of merchant cash providers take a fixed percentage of your daily credit card receipt volume until the advance you took is paid back. Other business cash advance providers may offer a fixed monthly installment payment for its repayment method.
- Credit Partner – Using a business partner(s) as a credit partner for obtaining lines of credit in the form of business credit cards can be a viable solution to overcome a personal credit challenge. A business partner who has strong credit scores is the best place to look. You may also want to consider someone who may be interested in participating in your business as a potential credit partner. This method does bring risk to the credit partner because they are cosigning with the business to obtain funding. However, these types of unsecured business credit cards will not appear on the personal credit reports of the cosigner unless they go into default.
The credit score is just as important as the source of funding when it comes to starting a business. Unforeseen circumstances, live events, or economic factors can all contribute to a fallen credit score. But your credit score is not the only factor in achieving credit worthiness. Your business plan, partnerships and other credit relationships can help your achieve your goals and dreams as an entrepreneur.
Balovich, D. (210, December 7). What Causes Businesses To Fail? Retrieved November 25, 2016, from http://www.creditworthy.com/3jm/articles/cw12710.html
Brown, C. M. (n.d.). How Your Personal Credit Score Affects Small Business Lending. Retrieved November 21, 2016, from http://www.blackenterprise.com/small-business/how-your-personal-credit-score-affects-small-business-lending/
Causes of financial problems. (n.d.). Retrieved November 21, 2016, from http://ginsberg-gingras.com/en/understand/causes-of-financial-problems
Fay, Bill (n.d.). Obtaining Credit for a Small Business – Manage Debt & Build Credit. Retrieved November 20, 2016, from https://www.debt.org/small-business/obtaining-credit/
Guina, R. (2016, October 11). The 2008-2009 Financial Crisis – Causes and Effects. Retrieved November 25, 2016, from http://cashmoneylife.com/economic-financial-crisis-2008-causes/
McCormick, M. (n.d.). Starting a Business With Bad Personal Credit. Retrieved November 21, 2016, from http://smallbusiness.chron.com/starting-business-bad-personal-credit-4694.html
Roth, J. D. (2016, May 25). Starting a Business After a Job Loss. Retrieved November 25, 2016, from http://www.getrichslowly.org/blog/2009/05/17/starting-a-business-after-a-job-loss/
Wasserman, Noam. (2012) The Founder’s Dilemmas. Princeton, NJ: Princeton University Press.
What is a Good Credit Score? (2016). Retrieved November 26, 2016, from http://www.experian.com/blogs/ask-experian/credit-education/score-basics/what-is-a-good-credit-score/
Zoldak, A. (n.d.). Startup Business Problems. Retrieved November 21, 2016, from http://smallbusiness.chron.com/startup-business-problems-2391.html