For entrepreneurs, creditworthiness can be a critical factor when growing a business. The ability of a business owner to secure business credit cards, loans, and lines of credit with competitive interest rates, supplier credits, and insurance can all be impacted by their consumer and business credit. While businesses grow, their owner’s personal consumer credit is often leveraged to obtain funding, credit, or other debt. In addition, a business owner may be required to guarantee some forms of business credit using their personal consumer credit.
This article explores consumer and business credit, offering tips for leveraging both to maximize business sustainability.
What is credit?
Investopedia defines credit as “…a contractual agreement in which a borrower receives a sum of money or something else of value and commits to repaying the lender at a later date, typically with interest. Credit can also refer to the creditworthiness or credit history of an individual or a company.”
When is a business owner’s personal consumer a factor as an entrepreneur/small business owner?
A business owner’s personal consumer credit is most significant in the beginning stages of a business. This is because early-stage businesses/start-ups do not have a credit history.
For items such as trade/supplier credits, loans, credit cards, and lines of credit, financial institutions/creditors will often rely on the owner’s consumer credit to issue debt to the business. Business owners can also be required to guarantee the business’s obligations as a safeguard or collateral for credit issuers. Additionally, some insurance companies may review business owners’ personal consumer credit to determine their ability to make timely premium payments. As a business grows and establishes credit, financial institutions/creditors will rely less on the owner’s personal credit.
Examples of when business owner’s consumer credit is used:
- Establishing business bank accounts
- Applying for loans (auto, mortgage, line of credit, etc.)
- Applying for credit cards
- Applying for business credit with other businesses – trade credits
How the credit industry works:
In the mid-19th century, the credit rating system used in business today was created to monitor the creditworthiness of individuals and companies. In the 1950s, the credit rating industry began collecting detailed information about companies and individuals, including length of credit history, payment history, outstanding debts, and other financial data to approve debt. Industry leaders in this sector are Dun & Bradstreet, TransUnion, Equifax, and Experian.
What is a credit score?
A credit score is derived from a mathematical formula to determine a ranking. This ranking determines whether the business or individual has poor, fair, good, or excellent creditworthiness. For businesses, credit rankings vary by credit bureau and are explained below:
CONSUMER CREDIT (US):
- Major Credit Bureaus: Equifax, Transunion, Experian
- Credit Scoring System: FICO
- Scoring Range: 300 – 850
- Higher scores reflect more creditworthiness
Tips for maintaining a high consumer credit score:
- Paying bills and obligations on time
- Maintaining low revolving debt – credit cards, lines of credit (home equity, personal, retail)
- Maintaining a healthy credit mix of different types of debt – mortgage, auto loans, student loans, credit cards, etc.
- Maintaining accounts for a long time to establish a credit history
- Keeping credit inquiries low – only having credit run when necessary
- Checking credit reports often to ensure accuracy
- Credit Scoring System: Paydex Score
- Scoring Range: 1 – 100
- Higher score indicates creditworthiness
- 80 or higher is considered a good credit rating
- Credit Scoring System: Intelliscore Plus
- Scoring Range: 0 – 100
- Higher score indicates lower credit risk
- 76 or higher is considered excellent credit
- Credit Scoring System: Business Credit Risk
- Scoring Range: 101 – 992
- Higher credit score indicates a lower credit risk
- 670 or higher is considered a good credit rating
How does a business owner establish business credit?
Establishing business as a separate entity and creating a “corporate veil”:
- Obtaining an EIN for the business and operating it as an independent entity from the owner (an LLC is a popular structure for this separation)
- A corporate veil is a legal concept that protects an owner from personal liability as related to the business. To prevent the commingling of business and personal funds, it is recommended that business owners create policies and documentation procedures for transferring funds in and out of the company.
Separate business bank account(s):
- Establishing a separate bank account is an important step in keeping the business’s funds separate from the owner’s. All funds transfers between the business and its owners should be documented and accounted for using the proper accounting methods.
Business credit card:
- Obtaining a credit card for the business can be a great way to establish credit. Timely payments of company credit cards count toward favorable credit ratings.
Establishing trade credit with other businesses (B2B):
- If a business works with other businesses to acquire supplies, services, materials, and other items, these items could be purchased on credit and paid for later, as agreed upon by the parties. Timely payments of trade credits can favorably impact business credit.
Keeping credit bureaus updated and running credit reports for business:
- It is recommended that businesses register for all three major business credit bureaus to track and monitor their business credit. The accuracy of these reports can greatly impact the business’s ability to establish credit.
Maintaining favorable credit as a business owner can greatly improve a business’s ability to access much-needed capital as it grows. While personal consumer credit may be a factor in the early stages of a business, the eventual establishment of strong business credit can result in lower interest rates, favorable payment terms, attractiveness to investors, trade credits, and an overall positive reputation that will help the business grow.