Businesses with low credit scores are unlikely to obtain access to affordable financing. This may seem like a matter of common sense to bankers, but applicants with low credit scores are often surprised when they’re turned down — or offered less favorable terms than expected. Before prospective borrowers submit loan applications, remind them about the importance of establishing and maintaining the highest business credit score possible.
Separate personal and business credit
Many private business owners underestimate the importance of establishing strong business credit from the get-go. Rather than deal with the red tape of applying for bank loans, they rely on shareholder loans or advances from family members to finance growth.
Eventually most businesses outgrow the owners’ personal resources, requiring them to apply for bank loans. But an application may be turned down or a loan issued at a higher interest rate or lower amount than the owner anticipated. The reason is simple: The owner failed to establish a separate credit history for the business.
Establishing a business credit history offers several other advantages. It helps insulate the owner’s personal assets from legal or credit claims against the business. Banks also tend to lend higher amounts at more favorable terms to businesses than individuals with similar risk profiles. And, although it’s not reported on the balance sheet, established business credit is an intangible asset that can make a borrower more attractive to potential investors.
Pay on time
Building credit for small businesses often starts with a corporate credit card that’s paid off monthly. But strong, established credit histories require more diverse loan portfolios that also include equipment loans, credit lines and leases.
Businesses should start small when they don’t need it and pay what’s due, when it’s due — or early. That way, when they really need bank financing, their credit history will be long established.
Understand business credit scores
There are several business credit reporting agencies, such as Experian, Equifax, and Dun & Bradstreet. Each agency has its own algorithm for calculating credit scores. The higher a company’s credit score is, the lower its credit risk. Business credit starts when a borrower registers with business credit bureaus under its employer identification number (EIN).
The credit agency takes key facts from the company’s registration, including its address, phone number, owners’ names and industry classification code. The agency also searches the Internet and public records for bankruptcies, judgments and tax liens against the borrower. On an ongoing basis, creditors report payment experiences with the borrower to the credit agency.
Companies with proven track records generally score higher than start-ups. Once a company establishes credit, it needs to use its borrowing capacity periodically — or risk being downgraded. In addition to timely bill payment, credit scores factor in such characteristics as size, business structure and industry risk.
For example, higher net worth or annual revenues will typically result in a higher credit score. In addition, C corporations, S corporations and limited liability companies tend to receive higher scores than sole proprietorships and partnerships. Some agencies even keep track of the percentage of companies under the company’s industry classification code that have filed for bankruptcy. Participation in high-risk industries lowers a business’s credit score.
Borrowers should check their credit scores on a regular basis. If a company’s credit score has been unexpectedly lowered, the owner should contact the agency to find out why. In some cases, they may be willing to increase the credit score, if the owner can successfully prove that the downgrade was unwarranted.
Make lemonade from lemons
Bankers must sometimes be the bearer of the bad news that a loan application has been rejected due to a low credit score. But the relationship may still be salvageable if the applicant is willing to build and improve its business credit score over time — and then reapply for another loan later on. Keeping the relationship alive may lead to more satisfying loans for both parties down the road.
For more information on Smith and Howard’s commercial banking services, please contact Marvin Willis at 404-874-6244.
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