8 Things Every Entrepreneur Needs to Know About Credit

By Alex Day

Getting a business off the ground requires capital.  One of the most often used means of funding an early stage business is with credit. Credit is probably the easiest way to access capital for your business.  Below are some of the things that every entrepreneur should know about credit.

1.  Know your credit score.  If you have a realistic shot at getting credit to fund your business, you need to know your credit score.  There are numerous different algorithms for how credit scores are calculated.  Essentially the different items that are taken into consideration are:

·         How much credit you have access to- How many credit cards and lines of credit?

·         How much credit you are using- How close are you to the limits on your credit cards?

·         Your payment history- Do you pay on time or have you defaulted?

This is an oversimplification, but these are essentially the things that impact your score.  If you have a bankruptcy or judgments against you, these items can have a major detrimental impact on your score. 

2. Know the difference between your "credit report" and your credit score.  The federal government passed a law that you are entitled to your credit report once a year, or any time you have been declined credit.  The credit reporting companies have not made it easy to access these free reports, and even when you do, they do not come with the credit score.  This is something that is calculated differently by different groups.  So you can get a free credit report, but you can NOT get a free credit score.

3. Know your score from the three main credit reporting agencies.  Although many different groups may generate their own method for calculating a credit score for you from your credit report, you should know your score from Experian, Transunion and Equifax.  These are the three main credit reporting agencies and you should know your scores from them.  If there are major discrepancies between these, then there is probably a mistake somewhere.  Also keep in mind that most of these sites automatically sign you up for monthly credit monitoring (which I believe is worth the money), and you usually have to opt out or you will be charged a monthly fee to get the score and other related data each month.

4. You can improve your credit score.  Once you understand the science behind how credit scores are calculated you can take steps to improve your score.  There are some things that are counter intuitive about your credit score.  For instance if you get a credit card paid down and then cancel it, this can actually negatively impact your score.  That is because part of the factor in your score is the ratio of the amount of revolving credit you have available to the amount you have used.  So if you have 3 credit cards maxed out, you pay one off, but keep it open, it has positively impacted your score.  If you pay it off and then close it, so that the amount of available credit you have available goes down, it can decrease your credit score, even though you paid off that big credit card. 

5. Know the difference between secured debt and unsecured debt.  Credit cards are unsecured debt.  If you fail to pay them, it is difficult (but not impossible) for the credit card companies to attach your assets.  Secured debt means that something is attached to that debt.  One of the most common forms of secured debt is your home loan.  If you attempt to get a loan from the Small Business Administration or from a bank for your business, they are likely going to require you to sign personally and to pledge your home.  This means that if the business fails, the bank can foreclose on your house to collect their debt.

6. Know the factors that the banks will look at if you go for a bank loan.  The factors that the bank will look at are your credit score, your cash flow, and your experience.  If you are just starting your business then they will require a personal signature and will require at least your past three year tax returns.  They will also require that you have the free cash flow to support the debt.  Remember that this is not based on your sales projections, but will be based on the income you reported on your past taxes.  If you do not show on your taxes that you could support the loan, then it is unlikely that you will get the loan based on your business projections.  It is always good knowing what your credit score is before you go to the bank, and if it is low, you may not want to waste your time.  At the very least, be upfront with the banker and tell them about the issues on your credit report up front, rather than applying and then they find it on the report they pull.  They may tell you to go ahead and apply, but they will be aware of the situation and this improves your credibility with the bank.

7. Keep as much of the debt in the company's name without signing personally.  This is usually very difficult early on, but there are instances where you can get credit in the company alone (or things that are like credit). Things like leases, equipment loans, and utilities are things that you can probably get in the company's name and if things go south, you can capture the debt in the company instead of with you personally.

8. Start building your businesses credit as soon as possible. If you want to eventually be able to get credit in your business name, then be sure to start putting the foundation in place to build credit.  You HAVE to have a business banking account, and you HAVE to run all your sales and your business expenses through that account.  You also have to be sure to file your taxes on your business.  These are critical factors to being able to get credit in your company's name.  

Remember that early on in your business your personal credit is important.  Most creditors don't consider your business real, until it has existed for at least two years.  So early on virtually all credit decisions for your business will be based on your personal credit score and credit history.  To get your credit score you can visit these types of sites:   www.annualcreditreport.com or  www.creditkarma.com.  You can always go direct to each of the credit bureaus for a credit report, such as https://www.equifax.com/personal/education/credit/report/how-to-get-your-free-credit-report/

 or https://www.transunion.com/.