Back when I practiced law, my favorite client ever was a fun, loquacious, gregarious guy we will call Craig. Craig owned the coolest shop ever, specializing in old pinball machines, jukeboxes, neon clocks, slot machines, that sort of thing.
While he clearly had an eye for desirable collectibles, what Craig didn’t have was a nose for business. He is one of those people who became an entrepreneur because he had a passion for something, but, like many of his small business brethren, didn’t really know much about the business side of business, especially money, finances, credit, and so on.
Of the many mistakes Craig made in business, the biggest one was that he never separated himself personally, legally, or financially from his shop. He comingled business and personal funds, uksed his social security number to establish business credit, and never incorporated. As a result, when his small business went through some tough financial times, his personal credit rating took a big hit. And thereafter he was unable to find the capital he needed to keep the shop running properly.
Eventually, Craig declared bankruptcy and lost his store.
Financial issues like that are all too common for small businesses (especially startups), but the good news is that they are easily correctable. Why don’t more small business owners uncouple themselves legally and financially from their business and create separate business credit? In my experience, it is usually because they don’t know how. While we all know how personal credit works and how to build and maintain a solid credit profile, establishing and maintaining positive business credit is a bit more mysterious. But it need not be.
Understanding Business Credit
You have a personal credit history and personal credit rating. That personal rating helps you get loans for cars and homes and so on. Well, similarly, the same idea applies to your business (albeit the loans are of course needed for different purposes.) Indeed, having a separate and distinct credit profile, and creating and maintaining a strong business credit score, can help your small business in all sorts of ways.
For starters, having a solid business credit file and building business credit will enable you to get loans from lenders that can help grow the business. If you need to buy that expensive equipment or machinery for instance, a good credit profile can help. It can help get better credit terms and better interest rates with important wholesalers and suppliers. Having good small business credit can even help attract investors.
Conversely, having no business credit, or maybe worse—bad business credit—can crimp your business in all sorts of ways too. Without the ability to get loans when needed, you may miss out on great opportunities that come your way. You will definitely pay more for the credit you do get. Also, without a good business credit profile, you may even find that vendors do not want to work with you.
So, what is business credit based on? Essentially, it is the same as personal credit:
- Does the business pay its bills on time?
- How much, or how little, debt does the business carry and need?
- Does the business have a history of litigation?
- Does the business do business with, and get credit from, established lenders?
So yes, having good business credit therefore will save you money, help you grow, and secure cash flow.
There is one more reason—a personal reason—that creating and maintaining solid business credit is important: It may remove the need for a personal guarantee. Now don’t get me wrong: yes, there are plenty of times when a business applies for credit that the owner has to give a personal guarantee. Small Business Administration (SBA) loans for example, are notorious for wanting a personal guarantee from the owner.
But “most of the time” is not the same as “all of the time.” There are in fact times when a personal guarantee is desired but not required. In those situations, having solid and separate business credit works in your favor. Experian will like that!
So the need for separate business credit is pretty obvious. What is not quite so obvious is how to establish it. Here’s how:
How to Establish Business Credit
There are six steps to start building a unique business credit profile that will be noticed by business credit bureaus:
Step 1: First, You Need to Incorporate
As you know, a corporation is a separate legal entity, distinct from you. This is not true if you run your business as a sole proprietorship or a partnership; only corporations and Limited Liability Companies (LLCs) are separate legal entities.
As such, it should make sense that the first step in creating separate business credit is to create a business entity that is legally different than you. Once you do that, you can begin the process of creating credit in the name of the business.
How do you incorporate? Easy! In fact, this is one of those nice times when a lawyer is not needed. Simply go to a DIY legal site like LegalZoom or RocketLawyer and find the “Incorporation” tab or button. Scroll to your state and buy the package. Probably $99. Fill out the forms and file them with the Secretary of State of your state. Boom, done!
Step 2. Get an Employee Identification Number
An Employer Identification Number (EIN) is sort of like the Social Security number of your business. It is issued by the IRS and identifies your business for tax and credit purposes.
Once you have incorporated and have gotten an EIN in the name of the corporate entity, you have set the stage for establishing business credit because your corporation is now a stand-alone legal entity.
Step 3. Set up Bank Accounts in the Name of the Business
Using your newly incorporated business name and EIN, the next step is to go to a bank and open two accounts: A business checking account and a business savings account. This is valuable for two reasons:
- Credit agencies will pick up on the new business account.
- It will allow you to take out a small business loan.
This part of this process is a bit of a Catch-22. You need business credit to get a business loan, but you can’t get business loan until you have business credit. What do you do? This step is the solution.
Even though you do not have an American Express platinum card card quite yet, you can begin your journey by taking out a SECURED small bank loan; that is, your savings account acts as a security device for the loan. It’s sort of like how a house secures a mortgage. Don’t pay the loan, and the bank takes the security device.
Then, once you begin to pay back the loan regularly, the upshot is also two-fold:
- First, you will have established business credit (and positive business credit at that).
- Also, your bank will report your business favorably to credit agencies as a good credit risk.
A similar option would be to open a business credit card. This, however, is somewhat problematic as–as indicated–getting credit without having credit is the issue. That said, you may be able to find a card issuer looking for new customers that may have more flexible terms and conditions than usual. If so, great, go for it.
Either way, the upshot is that by getting a financial institution to work with you, you will have established business credit.
Step 4. Establish Commercial and Trade Credit
Armed with your newfound business credit, you should also work to get some commercial credit in the name of the business–with office supply stores, wholesalers, suppliers, that sort of thing. This will really begin to solidify your new business credit profile.
Especially important to this process is establishing some net-30 accounts with a few vendors. As you know, net-30 allows you to buy now and not pay for 30 days. Those 30 days of credit are what we are looking for. The key, for our purposes, is to make sure that the vendor reports their credit accounts to commercial credit agencies like Experian (if we are trying to establish business credit, there is little point in getting that credit if no-one knows about it).
Step 5. Keep Personal and Business Credit Separate
Needless to say, the whole point of jumping through all of these hoops is to separate your business finances from your personal finances. As such, it is incumbent upon you to keep them apart. While you might be tempted to use that business credit card the next time you are at Costco, don’t.
Step 6. Pay on Time
You know the drill. The one sure way to ruin a credit score is to pay late. Paying your business bills on time tells the credit world that your business is trustworthy, and credit worthy, and therefore worthy of additional credit.
Maintaining and Improving Business Credit
Once you have established business credit, the next step is to be sure to maintain it. Business credit is similar to, but still distinct from, personal credit. Whereas your personal credit rating and personal credit score ranges between 300 and 850, business credit reporting agencies rate businesses between 0 and 100. In the business credit world, anything above a 75 is desirable.
A business credit report will examine creditworthiness by looking at, and taking into account:
- Tax ID number
- Type of business
- Credit payment history and credit limits
- Account openings and closing
- Business credit history
- Liens and judgments
- Credit inquiries
- Outstanding balances
- Credit utilization
And just like personal credit, it is vital to be diligent and monitor your business credit profile regularly as well. It is estimated that a billion pieces of credit flow into credit profiles every month. As such, they are, frankly, rife with mistakes. For example:
- It could be that a creditor mistakenly reported your business negatively to various credit bureaus when in fact you never paid late.
- There may be a company whose name is very similar to yours, and a ding to their credit is mistakenly attributed to your business.
- It’s possible an old debt that was paid off years ago is still showing up on your business credit report.
Whatever the case, you won’t know unless you monitor your business credit profile. You can check your Experian business credit report here, your Equifax business credit report here, and your Dun & Bradstreet report here.
How Do You Improve Your Credit Score?
All of this then begs the question: What if you do find negative things on your credit report? How do you clean it up? The answer depends on what it is that you find.
If you find a mistake on your credit report, you can, and need to, dispute it. The Federal Trade Commission says that you should write to the credit agency, explain what you think is wrong, provide copies of documents that support your dispute, keep good records, and follow up.
If your credit report is accurate, but shows a negative history, know that credit reports are most certainly not set in stone and can be changed. Contact the company that reported your business and see if you can resolve it somehow in exchange for having them remove the negative mark or otherwise report it as resolved. It may be that you will have to pay a late charge or maybe there is an old debt that was never handled. Whatever the case and whatever the payment terms, handling it and getting it off your credit can only help.
Going forward, the best thing you can do is to pay your debts in full and on time. While obvious, it is also true that within about a year, you will see a vastly improved credit score. Within a few years, your business credit score will be such that you will be able to get far more affordable loans, lines of credit, and more.
And when that happens, having bad credit will be as rare as one of my pal Craig’s old jukeboxes.