Credit Management Inc.~ Your Guideline to Credit Stability
"Your Guideline to Credit Stability"
"Your Guideline To Credit Stability"


Building Business Credit

There are a myriad of hurdles that small businesses encounter, not the least of which is gaining access to capital. Small businesses are typically financed by owners, the owner’s friends and family, the owner’s credit cards, or a combination of each.

The need for cash among small businesses is often never ending.  Even the most successful businesses require constant infusions of cash in order to grow.  Growing businesses often find themselves in a “cart before the horse” scenario where they have to spend money first, to make money later.  Virtually every business that has ever started has had to spend money first before they make their first sale.  They have to buy office equipment, stationary, license fees, incorporation costs, telephone service, leases, etc.  The list goes on.

We’ve all heard about Angel Investors, Venture Capitalists, and small business loans but only about 3% of all businesses receive startup funding from sources that are not derived from the owners themselves or their immediate friends and family. 

This said, you may have to start your business with your own source of funding but your growth capital going forward can come from a number of third party sources.  But in order to qualify for third party financing, or favorable credit terms, business owners must position their companies to be financiable as soon as possible.  Even well established companies have to go through a step-by-step process to position their company as a stand-alone entity worthy of gaining investment or credit based financing.

Most small businesses are merely an extension of their owners, meaning any credit or financing terms are usually secured by the owner’s personal credit.  This can be dangerous ground to tread.  9 out of 10 businesses fail in the first 3 years and often wreak hardship on the owners who financed their failed companies with their own credit.

So here’s what you can do to turn your company into a separate entity that succeeds or fails on its own, while removing much of the risk to you as an individual.  To do so, you must build your company’s credit profile, separately from your own.

The process is long and involved. Creditors don’t make it easy on small businesses because they want to keep owners personally liable for debts. But the CEO of IBM doesn’t have to put their social security number on the line, or sign a personal guarantee, when the company needs to borrow money—and neither should you. Here’s what you can do to turn your company into a separate entity. The process can take many months, even years, but most entrepreneurial veterans will tell you it’s worth it.

Start Small, Start Today

Just like personal credit scores, your business can achieve a credit rating that can qualify the company for financing. If you pay special attention to building business credit, your business can achieve financing within a year, upwards of hundreds of thousands of dollars at little risk to you, the owner.  There are services available that can walk you through the steps for a hefty fee, a few thousand dollars, but you can do the same on your own at virtually no cost other than time and effort.  Incidentally, you’d have to spend much of the same time and effort even if you did hire a credit specialist.

Visit the website for Dun and Bradstreet, www.dnb.com.  They are perhaps the leading business credit bureau, along with Experian, and they will allow you to set up a credit profile for your business.  They charge a few hundred dollars for this service if you are in a rush, otherwise, you can build your profile for free following these procedures:

Have a Legal Business Entity

Set up a legal entity, separate from yourself, such as an Incorporation or LLC.  You can’t be a sole proprietor and separate yourself from your company.  Incorporating or setting up an LLC is relatively easy and inexpensive. Almost every newspaper will contain ads for services that will help you through this.  You can also visit www.mycorporation.com.

Stay Consistent with the Company’s name.

Make it a habit to always refer to your company’s name the same way with every license you apply for, advertisements you take out, and paperwork you fill out for vendors or taxes, etc.  If your business name is Joe’s Plumbing Service, Inc., don’t abbreviate it as JPS, Inc., when filling out paperwork for any business related service. And be sure your vendors list you the same way with any of their related paperwork.

Location, Location, Location

Maintain a physical address for your business, even if it is your home, for regular mail.  Refrain from using a P.O. Box. You should also have a business phone and fax line linked to your physical location and be sure you are listed correctly in the phone book and with directory assistance.  You should also have a virtual location such as a website and email accounts. You can visit www.networksolutions.com to set this up.

Get Licensed

Be sure that you have received all pertinent licenses to do business and follow regulatory guidelines in your City, County and State as mandated by Law.  This is critical to building a positive credit profile.

Financial Information

You should keep good financial records, which include a Balance Sheet and an Income Statement for at least two years. If you’ve just started the company, begin this process immediately.  It is also encouraged to use a third party CPA to build credibility.

Taxes

Be sure that you have a Tax ID (EIN) number for you business.  This is to businesses what your social security number is to your personal finances.  You will supply this number when applying for credit instead of using your social security number. When credit is granted solely tied to your company’s tax ID number, you remove a lot of personal risk.  Remember to make sure that both your Federal and State business tax ID numbers are registered to the exact same business entity name.

Bank Ratings and References

Your business must have at least one bank reference.  In the perfect world, your bank account should have at least a two-year track record, but more importantly, your account should maintain an average balance of at least $7000 for at least the most recent 3 months. Most lenders make credit decisions based on your ability to make installment payments so; obviously, your account’s average daily minimum balance should be higher than the monthly installment payment on a desired loan.

Bank Ratings are categorized as follows:

Bank Rating                                                                             Average Account Balance
Low 4                                                                                      $1,000 - $3,999
Mid 4                                                                                       $4,000 - $6,999
High 4                                                                                      $7,000 - $9,999
Low 5                                                                                      $10,000 - $39,999
Mid 5                                                                                       $40,000 - $69,999
High 5                                                                                      $70,000 - $99,999
Low 6                                                                                      $100,000 - $399,999

According to the chart above, if your loan request involves a monthly installment payment of $2,000, banks will want to see a bank rating on your account in the “low 5” category.  Banks want to see that you have more than enough in your account to cover any installment payment. Experts suggest that a “low 5” rating is the magic number for substantial loan approvals, therefore, it is best to keep an average balance at or above $10,000, but at least above $7,000.

Lastly, make sure the name and address on your business bank account is the exact same as that of your legal business name,
which is also the exact same as that registered with your Tax ID numbers.  Make sure the address is a physical address and not a P.O. Box.

Business Credit Reporting Agencies

There is a distinct difference between business credit reporting agencies (such as Dun and Bradstreet) and personal credit reporting agencies (such as Transunion, Experian, and Equifax).  Experian does have a business-reporting department but you should understand the difference between both departments.  Dun and Bradstreet (D&B) is the leading Business Credit Reporting agency in the U.S. and they provide businesses with a separate credit file number, “Duns Number”, used to rate your business credit profile.

Obtaining a Duns Number is free and this will be used to build your business credit profile.  Lenders will access this number to
get the inside view on your business’ creditworthiness.  And your business creditworthiness will be determined by your trade references and what they’ve reported about your business’ payment history.  While you’re going through the process of setting up your business to achieve its own credit profile as a stand alone entity, be sure to establish positive payment histories with some key vendors. They will become your trade references.

Trade References

The process involved in getting your business established as a stand-alone entity can be long and arduous. Even under aggressive adherence to the above guideline, it can still take months.  It is critical to not skip any of the steps above. Take your time and do it methodically.

Your business will need 5 trade references that have extended your company payment terms and to whom your business has paid on time according to those terms.  These trade references must also report a favorable credit history to D&B. If your trade references are not reporting to D&B about you, ask them to.  This will establish your “PayDex Score” with D&B and, like your personal credit score, will become a vital deciding factor in determining your businesses creditworthiness.

PayDex Score

Once you have 5 trade references reporting your credit history with D&B, your PayDex score will begin to calculate. This score is a 1 to 100 scale and is calculated by using up to 875 payment experiences.  This score can take time to build, as it requires your trade references to report your payment activity.  It goes without saying that you’ll want their reports to be favorable so you must pay them on time.  Following is the PayDex scale and the goal would be to establish a score of at least 75 to get increased access to credit.

PayDex Score                                                                          Payment History
100                                                                  Early to 30 days

  1. Early to 10 days
  2. Paid as Agreed
  3. Slow to 8 days
  4. Slow to 15 days
  5. Slow to 22 days
  6. Slow to 30 days
  7. Slow to 60 days
  8. Slow to 90 days
  9. Slow to 120 days

Conclusion

The items and order of everything above is what’s necessary to build your business’ creditworthiness. The process is long and involved.  Experts suggest this to be a 6-month to 2-year progression. There are services and consultants who will offer a speedier approach and will charge excessive fees to tell you the same thing outlined above.  In the end, it will still come down to your doing most of the work.  But done successfully, you will achieve two very important things: build wealth and reduce personal risk.  With a PayDex score of 75 or better, it is quite possible to receive hundreds of thousands of dollars in credit that will be tied to your business entity and not to you personally.  There are endless things you can do with such credit to increase the value of your company, which in turn increases your value, without risking your personal wealth or credit.  The CEO of IBM doesn’t sign personal guarantees for IBM and doesn’t worry about losing their house if IBM fails and neither should you.

 

 
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