Access to credit is the lifeblood of many small businesses.
Whether you have a fledgling start-up or a more established operation, credit can help you grow your business during the good times and keep it above water during the bad. Yet to make sure you can get credit when you need it (and with the best terms), you’ll need a good business credit score. Here’s what goes into your business credit score — and how to build a good one.
Good business credit scores let you be flexible with your funding
There are numerous sources of loans and credit lines available to small businesses. Many budding entrepreneurs start their business on a shoestring, relying on personal funds and creative use of credit before working their way up the credit ladder to more traditional sources of business lending.
That was the case for Justin Silverman, CEO of TheWarmingStore.com and the HealthandBodyStore.com, who started the two websites as a hobby with a friend and gradually built them into a full-time business.
“We started with personal funds, but soon our most valuable credit came from our suppliers,” says Silverman. “For our key suppliers that we did a lot of business with, we paid off bills in full each month. Now, when we need new suppliers, we use them for references. That makes it much easier to get new suppliers.”
The two business partners then added a couple business credit cards to the mix so that they’d have access to additional lines of credit should the need arise.
“We don’t need to make large capital investments to build space and such,” Silverman says. “So for now, we can get most of the credit we need from our suppliers, and just use the business credit cards for unexpected expenses.”
Yet the needs of your business may be different — and that’s why having a good business credit score is so important. For example, supplier credit may not be of much use to meet capital needs for business expansion. And, as many entrepreneurs discover the hard way, business credit cards have some drawbacks and penalties that end up costing them. If you have a good score, however, you’ll have your choice among business loans with good terms — and be able to use business credit cards strategically for short-term cash flow issues (and for their often lucrative rewards).
By the numbers
Just like individuals using credit, businesses develop a credit report and rating over time. Like FICO scores, business credit scores are used by lenders to determine the creditworthiness of a business. They are also used by other businesses to make decisions about the clients they do businesses with and on what terms.
The number of business credit reporting agencies is on the rise, and they all use somewhat different formulas for assigning business credit scores. The most commonly used business credit reporting agency remains Dun & Bradstreet, which uses the Paydex formula to assign businesses a credit score. Credit bureaus Experian and Equifax also measure business credit scores.
Business credit reports, like personal ones, include general information about the business, such as the company’s background, financial information, credit risk factors, banking and trade history, collection history (if any), past liens, judgments and bankruptcies. Yet business credit scores also differ from personal credit scores in crucial ways.
While personal credit scores are based on a variety of factors — including a payment history, credit utilization ratio and length of credit history, the Paydex score is determined far more simply. The main determining factor is when a business makes payments to its creditors.
Paydex business scores run from 0 to 100. A score of 80 is considered the “golden” number; it indicates that the business makes payments exactly on time. Scores of 90 to 100 indicate that the business tends to make payments even before the due date, while scores lower than 80 reflect late payments — the later the payment, the lower the score.
Experian business credit scores, meanwhile, also range from 0 to 100, but they differ from Paydex in that they are based on numerous factors contained in the business credit report — including the company’s overall size, trade experiences, outstanding balances, payment habits, credit utilization ratio, credit history over time and public records.
Equifax credit scores for businesses range from 101 to 816 — and predict the likelihood that a business will become delinquent on its accounts (late by 90 days or more) or go bankrupt in the next 12 months. The lower the score, the higher the risk.
Building the foundations of a good business credit score
Unlike with personal credit scores, business credit scores are not always established automatically. If you’re looking to apply for a small business loan, it’s recommended that you establish a business credit score at least four to six months before applying.
To build business credit, find a supplier that will not only issue credit to your business, but that will also report your payment record to the business credit ratings agencies. According to Experian, only about 10,000 out of 500,000 suppliers extending credit actually report payment history to ratings agencies. Encourage your suppliers to do so. Or, try to obtain a line of credit with another supplier that does.
Business credit activity is tracked, in part, by your employer identification number (EIN), so you may want to consider forming a corporation or an LLC. You can get an EIN if you run a sole proprietorship. Moreover, forming a corporation or an LLC affords you liability protection, and lenders are less likely to look at your personal credit history.
Once you have a business EIN, register it with Dun & Bradstreet, Experian, Equifax and Business Credit USA. And make sure that you comply with the business credit market requirements — such as having a business license and a phone line. Not having these things can be a red flag for the credit bureaus and lenders.
Another way to boost your business’s ability to get credit — polish your personal credit score. For small businesses, personal credit matters more than most realize.
“For small business people, the biggest thing is to take care of your personal credit first,” says Brian Dostal, a commercial loan officer with Community 1st Credit Union, in Ottumwa, Iowa. “If you’re the owner of a company and find a personal guarantor, we do a risk-based pricing off the personal credit record. If a person can’t handle their personal credit affairs, giving them business credit is probably not such a good proposition either.”
Once a business gets bigger, however, and is looking to take out loans from the Small Business Administration and other sources of commercial funding, personal credit becomes secondary to having a good business credit score.