How To Build Business Credit for Your Startup

Are you struggling to secure financing for your startup? You’re not alone. Startup financing can be tricky terrain, to say the least. In 2022 alone, a staggering 47% of startup failures were directly linked to inadequate financing. So, how do you tip the odds in your favor?

Well, we do have a starting point: credit scores. According to the National Small Business Association, 20% of small business loans were denied due to low credit scores. Unfortunately, this is what many startups tend to overlook, especially in the initial stages.

Even if you’re doing everything else right, a lack of business credit history can potentially trip your business up. So, how can you kickstart the process of building business credit for your startup and increase your chances of securing financing?

That’s exactly what we’ll cover in this blog post: why you need to build business credit, how you can do it, and how you can monitor it.

What Is Business Credit History?

Your credit history is the history of your financial behavior and credit-related activities. It includes information about your loans (your borrowing and repayment behavior), your credit cards, mortgages, and other forms of credit. The same applies to your business credit history.

A business credit score evaluates your company’s creditworthiness based on elements such as:

  • Past payment records
  • Available credit
  • Tax liens or bankruptcy filings

Your credit history is maintained by credit reporting agencies and is used by lenders to assess your or your business’s creditworthiness when considering whether to grant you a loan or credit. A positive credit history, indicated by timely and responsible repayments, can lead you to get loans/financing on more favorable terms and with higher credit limits. On the other hand, if you have a negative credit history, marked by late payments or defaults, it can be harder for you to secure credit or could mean that you get financing on less favorable terms.

What are credit bureaus?

A credit bureau is an agency that collects, collates, and analyzes credit information on individuals and businesses and sells this information to lenders and other parties. The business credit landscape is overseen by three primary credit bureaus: Dun & Bradstreet, Equifax, and Experian.

Each of these agencies generates multiple scores, providing potential creditors with valuable insights into your business’s financial well-being and its probability of making timely payments.

Why You Need To Build Business Credit

Business credit is an oft-neglected critical aspect of running a business. Securing financing, which depends significantly on your credit score, is a necessity for the survival and success of your business. But with that being said, there are more reasons you should turn your attention to it. Here are some other reasons why your startup needs to build business credit:

  • Separation of finances: Building business credit will help separate your personal finances from those of the business itself. This distinction is crucial for legal and financial purposes, protecting personal assets from business liabilities.
  • Credibility and trustworthiness: A strong business credit profile signals to suppliers, vendors, lenders, and potential clients that your startup is financially responsible and trustworthy. This can lead to better relationships and more favorable terms with partners.
  • Access to financing: Building business credit opens doors to various forms of financing. This can include loans, lines of credit, or business credit cards. A good credit profile makes it easier to secure the capital necessary for day-to-day operations, expansions, and unexpected expenses.
  • Negotiating power: With a robust credit history, a startup has more leverage when negotiating terms with suppliers, vendors, and lenders. This may result in better pricing, extended payment terms, or other favorable arrangements.
  • Lower insurance premiums: Some insurance providers use business credit scores to determine insurance premiums. A higher credit score may lead to lower costs for business insurance policies.
  • Lease agreements: Landlords and lessors may use a business’s credit profile to assess the risk of leasing office space or equipment. A strong credit history can lead to more favorable lease terms.
  • Preparation for emergencies: Having established credit can serve as a financial safety net in case of unforeseen circumstances or emergencies. It ensures that a startup has access to necessary funds quickly when needed most.
  • Reduced personal liability: With a solid business credit profile, there may be less need for personal guarantees on business loans or credit lines. This reduces the owner’s personal liability in case of business-related financial difficulties.
  • Laying a foundation for growth: As a startup grows, it may require more capital to fund expansion, hire employees, or invest in new equipment or technology. A strong credit profile provides the financial resources necessary to support growth initiatives.

How To Build Business Credit

What do Rome and credit history have in common?

Well, they can’t/won’t be built in a day.

However, the good news is that the process of building credit history can be broken down into several decisions you can strategically make.

Register your business

If you are a small business, the process of registering may involve no more than just formally recording your name with your relevant state and local authorities. But simply put, the method of registering your business hinges on both your location and chosen business structure. Once you’ve identified these factors, the registration process becomes relatively simple.

In certain scenarios, formal registration may not be required. Say, if you operate your business under your legal name, there may not be a need for formal registration.

But registering helps separate your business from you as an individual, making it easier to establish business credit. It also establishes certain boundaries between your financial affairs and your business; this could potentially help protect your personal assets from business debts, lawsuits, or losses. On the flipside, bypassing registration may result in a loss of personal liability safeguards, legal advantages, and potential tax benefits.

Get an EIN

An employer identification number (EIN) is a unique identifier for your business, similar to a Social Security Number for individuals. The IRS assigns this to businesses so it can easily identify them. If your primary business operations are based in the United States or US territories, you can request an EIN online. To get an EIN, the person making the online application must have a legitimate Taxpayer Identification Number, which can be an SSN, ITIN, or EIN. The IRS issues them immediately, and it looks like 12-3456789.

Open a business bank account

Ideally, your startup should have an exclusive business bank account that is distinct from your personal funds. It should be opened in your business’s legal name. By doing this, you essentially reinforce the distinct identity of your business and help show a history of healthy business spending (that is, again, distinct from your personal financial history). And this can go a long way in terms of:

  • Streamlining tax filing
  • Ensuring financial transparency
  • Building a business credit history

Establish a business address and phone number

Having a physical address and dedicated business phone number adds legitimacy to your business.

Register with credit bureaus

As we discussed earlier, credit bureaus collect financial/credit information (from sources like banks and lenders, incorporation filings, business registrations, the internet, etc.) about you and your business. Once you have your business registered and get your EIN, you’re all set to open your business credit file.

  • Experian: To open a file with Experian, you need to do business with a creditor or supplier that reports to this bureau. While it’s true that not every creditor reports to business credit agencies such as Experian, those that do will provide information about your payment history and outstanding balances. Consequently, it’s advisable to opt for vendors that do report to credit agencies whenever you can, as this will help in the development of your business credit profile.
  • Equifax: Much like the process with Experian, becoming registered with Equifax entails creating an account through an entity that shares transaction data with this credit bureau. Equifax is often considered one of the more challenging bureaus to become affiliated with, and the majority of the entities that provide data to Equifax are typically banks and leasing companies.
  • Dun & Bradstreet: Dun & Bradstreet maintain files for over 130 million companies. Obtaining a business credit score from D&B will require you to get a DUNS number (a unique nine-digit identification number for each physical location of your business), which you can get at no cost through Dun & Bradstreet’s official website. Lenders and fellow businesses frequently rely on this unique nine-digit identifier to assess your company’s credit standing and financial well-being prior to engaging in any business dealings with you. Additionally, securing a DUNS number is a prerequisite for applying for federal grants.

Obtain vendor credit

Vendor credit refers to a situation where your vendor allows you to make purchases and postpone payment until a later specified date. This type of accounts-payable relationship can boost your business credit score, provided your vendor reports payments to a business credit bureau. To kickstart this process, you can follow these three steps:

  • Have a discussion with your vendors about opening a credit line
  • Verify whether they actively report their credit arrangements to the major credit bureaus

If your current vendors do not report payment activities to credit bureaus, encourage them to do so or explore partnerships with ones that have such reporting mechanisms in place. Alternatively, you can list them as a trade reference on your account, and Dun & Bradstreet will follow up to collect your trade data.

This practice can substantially contribute to your business credit score and facilitate the gradual enhancement of your creditworthiness. Moreover, fostering trade relationships with vendors fosters trust, elevates financial partnerships, and positions your business for sustained growth and triumph in the fiercely competitive business arena.

Apply for a business credit card

A business credit card can be an effective way for you to establish business credit. Since issuers of business cards evaluate approval based on your personal credit, you can obtain a card even without an established business credit history. Early acquisition of a business credit card facilitates the initiation of credit-building, resulting in a more extensive credit history. This potentially leads to a stronger credit score down the line.

Furthermore, most small-business cards regularly report activity to business credit bureaus. Thus, making timely payments and maintaining low credit utilization (i.e., using less than 30% of your available credit) are beneficial in bolstering your business credit score. However, it’s important to note that missed payments can have adverse effects on both your business and personal credit ratings.

Importantly, while examining credit card options for your business, ensure that you understand the terms closely. Several credit cards hold you personally responsible for making payments. So, those transactions may not have any effect on boosting your business credit score.

Apply for a business line of credit or loan

Once you’ve established some credit history, consider applying for a small business line of credit or a small loan to further build credit.

Lease equipment or space

Leasing equipment or office space can be another way to build credit, as long as the leasing company reports to the credit bureaus.

Legal judgments, liens, and bankruptcy filings can have detrimental effects on your business credit rating. If your business accumulates unpaid taxes or debts, it may lead to a lien, granting creditors the legal authority to seize your assets to settle the owed amount. Moreover, outstanding debts can potentially lead to a court decision, or judgment, against your business to enforce debt repayment.

These adverse entries on your business credit report can have enduring consequences. For instance, bankruptcies can persist on your Experian credit score for a decade, while tax liens, judgments, and collections may linger for nearly seven years.

Utilize the credit you have (Don’t overutilize it though)

Once you obtain credit, you should utilize it. Having unutilized credit doesn’t exactly make you more qualified for a loan. This is because lenders might want to see you utilizing your credit. If you have credit sitting untouched, there would be no way of showing that you are capable of paying any potential loans advanced to you.

That said, lenders don’t want to see that you’ve overused your credit either, as this will flag you as a risker borrower. Keeping your credit utilization rate below 30% is recommended, but experts now say 10% utilization is what will get you that perfect credit score.

Establish and maintain good payment behavior

Your payment history is a major factor in your business credit score. Making timely payments is your responsibility, and it also goes a long way in showing that you are reliable. Making debt repayments on time and in full will help you build a stronger business credit profile over time.

As an example, Dun & Bradstreet uses the PAYDEX score (a score from 1 to 100), with 100 representing an excellent credit rating. Now, by making your payments promptly you can get a score of up to 80. But if you make your payments early, you can get a score of 100 on the PAYDEX scale. This may not be feasible every month, but it is worth doing when your cash flows permit.

Monitoring Your Business Credit

How can you ensure that your efforts to build your business’s credit history are paying off? To do this, you need to monitor your business’s credit score on a regular basis. To do this, you can:

  • Visit Annual Credit Report to check your personal credit score, a source of free credit reports that is authorized by federal law
  • Obtain your company’s credit report from Experian, Equifax, Dun & Bradstreet, or other several smaller credit reporting services

By doing this, you can not only track your business’s credit score but also keep an eye out for any errors. If you do find an error, you must contact the respective credit bureau(s) and seek to rectify it immediately.

Types of Business Credit

Business credit comes in various forms, each designed to meet different financial needs and situations. Here are some common types of business credit:

  • Business credit cards: These are similar to personal credit cards but are issued to a business. They allow businesses to make purchases on credit up to a certain limit.
  • Business lines of credit: This is a revolving credit account that works like a credit card, but usually comes with a lower interest rate. It provides flexibility for businesses to borrow up to a certain limit, repay, and borrow again.
  • Term loans: These are lump sums of money provided upfront, which are then paid back over a set term with interest. They can be secured (backed by collateral) or unsecured (not tied to specific assets).
  • Invoice financing/factoring: This involves a business selling its accounts receivable (unpaid invoices) to a third party at a discount. This provides immediate cash flow but at a reduced amount compared to the face value of the invoice.
  • Commercial real estate loans: These are loans specifically for purchasing or refinancing commercial properties. They can be for real estate development, acquisition, or renovation.
  • SBA loans (Small Business Administration): These are government-backed loans that provide favorable terms and lower interest rates to small businesses. They come in various forms, such as 7(a) loans, CDC/504 loans, and microloans.
  • Microloans: These are small, short-term loans, typically under $50,000 (with the average microloan at around $13,000), provided to help start or grow small businesses or some types of not-for-profit childcare centers.
  • Business overdraft: This is a short-term borrowing option where a business can withdraw more money than it has in its account, up to a certain limit.
  • Trade credit: As we saw earlier, this is credit extended by suppliers who allow a business to buy goods or services on account and pay for them later. It’s a common form of credit in many industries.

Key Takeaways

  • Inadequate financing is a major factor in startup failures, with 47% of failures in 2022 attributed to this issue.
  • Building business credit is crucial for startups, as 20% of small business loans are denied due to low credit scores.
  • Business credit history mirrors personal credit history, with creditworthiness being evaluated based on factors like payment records, available credit, and financial judgments.
  • Credit bureaus like Dun & Bradstreet, Equifax, and Experian play a pivotal role in assessing a business’s financial health for potential creditors.
  • Reasons to build business credit include separating personal and business finances, establishing credibility, gaining access to financing, negotiating better terms, and reducing personal liability.
  • Steps to build business credit include registering your business, obtaining an EIN, opening a business bank account, establishing a business address and phone number, and registering with credit bureaus.
  • Obtaining vendor credit, getting business credit cards, and availing business loans are effective tools for building business credit.
  • Avoiding legal liabilities, monitoring credit utilization, and maintaining good payment behavior are key strategies for strengthening business credit.
  • Regularly monitoring the business credit score and rectifying any errors are essential activities.
  • The different types of business credit include credit cards, lines of credit, term loans, invoice financing, commercial real estate loans, SBA loans, microloans, business overdrafts, and trade credit.

Conclusion

Building business credit is not merely a financial formality; it is a strategic move that can significantly impact the success and longevity of your startup. In an environment where securing financing can make or break a business, establishing a solid credit history provides a crucial foundation. It separates personal and business finances, enhances credibility, and opens doors to various forms of financing.

Moreover, it empowers startups with negotiating power, reduces founders’ personal liability, and positions them for sustained growth. But it’s important to remember that it is a gradual process that demands strategic steps, patience, and vigilance. By taking these steps diligently, you can create a solid foundation for your business’s financial future.