If you’re an entrepreneur, raising capital could be one of your primary concerns. Without money, you can’t perform essential business operations like building your product, marketing, and hiring workers.
Unfortunately, if you just established your small business, you may find yourself at a loss, trying to figure out how to build business credit. Owners often find themselves in a catch-22. They need funds to establish strong business credit, but they can’t secure these funds because they don’t have a credit history.
Many owners elect to turn to their personal lines of credit as a crutch. Although there are many similarities between business credit and personal credit, you must establish a distinction between the two to protect your personal assets.
Today, we’re here to provide you with a complete guide to how to build business credit. We’ve detailed why you should distinguish between your personal credit and business credit. We’ve also provided some tips you can use to build your business credit score.
What Is Business Credit?
Business credit is a tool that measures an organization’s financial responsibility. Other companies, banks, credit card issuers, and investors use your business credit score to determine whether they should work with and lend money to your business. A business credit score is similar to a personal credit score, which you may already be familiar with.
According to credit agency Experian, “Your business credit can be as important as your personal credit. Creditors and suppliers are increasingly using business credit reports to make lending and credit decisions.”
Personal Credit vs. Business Credit
When looking for ways to fund your business, you may be tempted to turn to your personal finances. This might especially be the case if you have a sound personal credit history, which can take years to build. Studies have found that more than 85% of business owners use their personal credit to fund company operations.
However, as tempting as this may be, you should make efforts to distinguish between personal and business finances. One of the biggest reasons for this is the “personal guarantee.” The personal guarantee states that because the owner is using personal credit reports, the debts of the business now become the personal responsibility of the owner.
So, for instance, let’s say a new company takes out a small business loan worth $10,000 and a business card with a credit limit of $5,000. The business quickly maxes out the credit card on rent and office supplies.
Shortly after the company opens, one of its primary suppliers goes out of business. The company scrambles for a new one but can’t seem to find one. The company is not making money.
High interest rates kick in on the credit lines because of late payments. Now, in addition to the $15,000 principal from the lines of credit, the company owes an additional $3,000 in interest.
The company ends up having to shut down. Because the owners used their personal credit to set up the company, they are now responsible for the $18,000 worth of business financing debt.
Many business owners choose to register as a limited liability company (LLC) because it protects owners and employees against company debts. However, this is not a given or something that owners should assume.
If owners seek protection under an LLC, they need to protect the “corporate veil.” The corporate veil assumes that business and personal activities are entirely separate from one another. The personal guarantee pierces the corporate veil, exposing owners to business risk.
Not only does maintaining separate accounts protect the corporate veil, it also makes things easier from an accounting perspective.
For instance, it’s much easier to track company expenses if they’re made from a dedicated business checking account. Credit agencies will also have an easier time monitoring business credit profiles and history if transactions occur across a line of credit dedicated to the company. You should consider creating a:
- Business address
- Business bank account
- Business phone number
- Business credit card
Understanding Your Business Credit File
Before attempting to improve your business credit, you first need to understand your business credit file. First and foremost, you likely already have some sort of file under your business name. That’s because business credit reporting agencies like Equifax and Experian will create a file using public records.
You can contact these agencies to receive a copy of your credit report. Doing so is an excellent way to view your business credit history and check if there are any correctable discrepancies.
Other business credit bureaus, such as Dun & Bradstreet, require you to apply for an account before you can establish a credit file. If you were to use Dun & Bradstreet, you’d receive a D-U-N-S number. Having a D-U-N-S number will allow you to work with government agencies, which can open up more business opportunities while also increasing your credibility. Additionally, Dun & Bradstreet is the most commonly used business credit reporting agency.
Dun & Bradstreet does not deal with personal credit, which is why you may not be as familiar with them. Instead of using a FICO Score, which is what agencies like Equifax and Experian use, Dun & Bradstreet rates credit using a Paydex Score. The Paydex Score ranges from 0-100. The higher the number, the less risky a business is.
How to Build Business Credit
Now that you have a better understanding of how personal credit and business credit are different, let’s take a look at some tips on how to establish business credit.
Register Your Business
If you’re a freelancer or entrepreneur, the first thing you should do is register your business in the state that you’re working in. You’ll choose items such as a business name and address. You’ll also register with the IRS to receive an employer identification number. Registering your business will allow you to establish a firm, black-and-white distinction between your personal and business accounts.
Establish Trade Lines
Another way to boost your business credit is by establishing trade lines with your suppliers. A trade line allows you to purchase from suppliers and then pay up to a few weeks after the initial order. Trade lines are very similar to credit cards, except they’re with a single entity.
If you already pay your suppliers on time, opening a trade line will allow you to get credit — no pun intended — for your prompt payments. By paying on time, you’ll boost your business credit score.
It’s very similar to paying with a debit card versus a credit card. If you typically spend with a debit card, you’re paying only with the funds you have. Credit cards give you a bit of wiggle room with when you make the payment. However, if you pay your credit cards on time, your credit score will go up, and you may even receive perks like airline miles or cashback.
Check Which Lenders Report to Business Credit Bureaus
It’s possible that you already have business lines of credit and make timely payments but just can’t seem to get your credit score to budge. If this is the case, you may want to check to see if the lender is reporting to business credit bureaus like Dun & Bradstreet.
This may especially be the case with an online lender. If you work with a lender who doesn’t report to business credit agencies, contact them to see if they’re willing to do so. If they’re not willing to do so, you may want to consider switching to another lender. Be sure to check the lender’s policy before you apply.
Practice Safe Financing Methods
Perhaps more important than anything is the fact that you need to borrow responsibly. Don’t take on debt knowing that you can’t repay it. You should take out and repay debt steadily. Make sure you pay your accounts on time and in full.
Also, don’t apply for too many credit lines at once. Each time a lender peeks at your credit file, your score will suffer. Gradually taking on debt is one of the best things you can do to boost your business credit score.
Raise Money for Your New Business
If you’re a small business owner looking to raise funds for your new company, building business credit is one of the best ways to do so. Doing so can set your business up for long-term success.
If you need cash in the meantime, be sure to check out crowdfunding sites like Kickstarter and GoFundMe. Crowdfunding sites allow you to start fundraising campaigns without having to reference your credit history. Also remember that you can build a passive revenue stream to help fund your operations.
With a little bit of hard work, you can secure the financial capital that your business needs to thrive, no matter what the current financial health of your firm is.