More and more entrepreneurs rely on their strong personal credit to fund a startup, but that can be another Catch-22. When you try to use your mortgage, personal credit cards or payment history to qualify for a business loan, it won't help to be carrying a lot of debt. Ultimately, your business credit will depend on your company's payment history, cash flow and assets; not your personal financial obligations, but it can take some time to build this record.
Why is a strong credit history so important for a business?
Not only will it be a foundation for capital funding, strong credit can also lower your interest rates and provide access to more capital in a hurry. Here are some tips for establishing a business credit record.
1. Set-up a Business Entity
In order to receive an investment or business loan, you must first separate your business from its owners by setting up a corporation, LLC or other business entity. Your accountant should be able to advise you on this and help you establish the proper legal structure for your situation, keeping in mind the potential tax implications of the entity you choose.
2. Establish a Tax ID Number (EIN)
Just like every American needs a Social Security number, every business must have its own tax ID number. A Tax ID number (or EIN) is a nine-digit number assigned by the IRS to business entities operating in the United States. You will use this number to open your business bank account and build your business credit profile. Applying for an EIN is a fast and simple process, which can be done online through the IRS website.
3. Open a Business Bank Account
When it comes time to apply for business credit, you will need at least one bank reference. Remember, when you apply for a business loan, that bank account must be at least two years old and it should show a cash flow that is capable of taking on debt from a business loan.
4. Get Listed with the Business Credit Bureaus
One of the most important measurements of a business' success it it's D & B rating or DUNS number. Dun & Bradstreet is one of the main business credit bureaus and runs its own business credit score. D&B gives businesses a separate credit file number that rates your credit profile. For more information, visit their site. You may find out that your business is already listed and has a score. If not, you can begin the process by applying for a free DUNS number once you've established your business entity and have your EIN. This number is how lenders will determine the credit worthiness of your business.
5. Establish Credit History for your Business
Find out if your trade vendors are reporting your payment history to one of the major reporting companies, like D&B. Similar to a personal credit score, the more vendors report a good payment history, the better your credit score will become. It's not uncommon for small trade vendors to avoid reporting your payment history to D&B. If this is the case, compile a trade reference sheet with at least three references to augment your official business credit report. In addition, open a business credit card account in the name of the business and use it wisely — meaning keep your balance low and make timely payments.
6. Maintain a Good Personal Credit Rating
When a company is new or relatively small, some creditors may look at the personal credit score of the business owner, or any shareholder with more than 20 percent equity. In today's competitive lending environment, expect to be asked for a personal guarantee on any loan or credit offered to the business. While not always mandatory, it has become more of a common practice in lending. As a result, you and any other shareholders should be careful to keep a stellar credit rating.
Business owners should think about their business credit from day one. It's important to remember that you can't build business credit overnight and it is a necessity. Even if you're self-funded now, you never know what challenges or growth opportunities will develop down the road. Having access to credit can only help you adapt to changing conditions and position yourself for success.
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