The BizFilings blog covering business tips and trends.
5 Steps to Establish and Maintain Small Business Credit
Published on Mar 12, 2012
Read the 5 Steps to Establish and Maintain Small Business Credit at 'Time to Start Up,' the small business blog by BizFilings.
Entrepreneurs are more likely to start off poor than rich. Harvard Business School professor and entrepreneurship icon Howard Stevenson recently reminded Inc. magazine of this fact.
"They see an opportunity and don't feel constrained from pursuing it because they lack resources," Stevenson said of entrepreneurs. "They're used to making do without resources."
Given that most small business owners don't have a substantial personal fortune to draw from, establishing and maintaining business credit is one of the most fundamental aspects of SMB finance. The U.S. Small Business Administration points out that most entrepreneurs are dreamers and leaders, not accountants, and might not feel inspired or equipped to handle the nuts and bolts of business credit. But by taking a few essential steps, entrepreneurs can successfully build their enterprise's credit.
1. Set up your legal business entity
If you're a sole proprietor, there's no clear distinction between a personal and business loan or personal and business credit, so this is one reason to register your business as a corporation or limited liability company. Doing so provides protection to owners by creating a distinction between personal and business finances, and prevents creditors from pursuing personal assets in the event that business debts need to be paid off. Forming an LLC requires filing Articles of Organization with appropriate state agencies and paying applicable fees. Each state has different guidelines for establishing and maintaining LLC status; for example, California requires an initial report within six months of incorporation, as well as an annual report and a minimum annual franchise tax of $800, while Delaware does not require an initial report, though Delaware LLCs must file an annual tax statement.
2. Open a small business bank account
Many small business owners use personal credit lines and bank accounts to get started, but to establish business credit history, it's crucial to open a commercial account. In order to apply for many types of loans, your bank account must be at least two years old, which is why it is important to set up your bank account expeditiously. In your account, you want a balance to show that you have the money available in order to take on debt and that you have built revenue over time. To obtain credit, businesses may need more than one bank reference to prove funds are available from a variety of sources.
Acquiring a business credit card can also be shrewd, as this is another way to separate personal from business credit. Business credit cards offer some advantages as well, such as statements that categorize spending. Of course, SMB owners should also consider fees and rewards programs, and shop around for a card that is a good fit.
3. Register with business credit bureaus
Setting up a complete profile with Dun & Bradstreet - one of the main business credit bureaus, which runs it own business credit score service - will help you see your credit score and what you need to do to improve it. You will be able to receive a free DUNS number from Dun & Bradstreet after you have created your business entity and once you have a federal tax ID number. Lenders will determine how worthy you are of receiving loans based in part upon your DUNS score. Other major business credit bureaus include Experian Business and Equifax Business.
Once you have a business credit file, it's essential to keep it up to date and monitor it to maintain a good rating. Credit score companies examine hundreds of factors to establish a rating, including a business' revenue and number of employees. SMB owners can refer to the FICO Small Business Scoring Service to lean more about what determines a credit score and how creditors use it to assess risk.
4. Showcase your ability to pay vendors and pay off credit cards
Your business credit will continue to build as vendors report that your business has a good payment history. Paying credit card balances and business invoices on or ahead of the due date can increase your business credit score while adding to your solid payment history. Creating your own trade reference sheet with at least three references, and attaching it to your business credit report, will show you are a good business partner.
5. Keep a strong personal credit history
Though establishing your business as an LLC or corporation creates separation between your business and personal finances, potential lenders may also look into your personal credit history when determining whether your business is worthy of receiving a loan. Any shareholder who owns at least 20 percent of a business may be evaluated by creditors and lenders, so it is important that each shareholder's credit history is as strong as possible. A personal credit score of 680 or higher will showcase financial responsibility.