In Part 1, we reviewed the table stakes for getting past that first underwriting stage in the SMB loan qualification process. You'll need to go through those steps at a bare minimum just to comply with automated qualification requirements.
This edition is all about establishing a business credit history in preparation for a loan.
It's a lot like building personal credit history - there are credit reporting bureaus, payment history, credit utilization, and account age factors to consider.
A few key differences:
- Unlike personal credit scores, which range from 300-850, business credit scores usually range from 0-100 (Equifax is different). 80+ is considered "very strong".
- Experian, the largest business reporting bureau, will open a report for your business based on public records data. As soon as you complete your corporate formation and get any vendors reporting, they will open a file on you.
- Certain ratings agencies, like Creditsafe, will provide credit limit recommendations - that is, advising on how much credit your business should have outstanding at any time.
Let's jump right in...
Establish A Business Credit Profile
There are actually several credit reporting bureaus that you will need to actively manage, and it's all part of building up the right business credit profile.
It's not unlike personal credit building, except that business credit is much more precise in its tracking. For example, personal credit reporting is based on 30 day increments.
So if you pay your personal credit card bill 29 days after it's due, you're on time. If you pay 10 days before it's due, you don't win anything.
With business credit, reporting is done to the day. Paying early actually has a marked advantage, and paying late by even a day will hurt you.
Experian Smart Business credit file
Experian is the biggest and easiest to get started with. Their reporting guidelines for vendors are the most open, so you can build up a history quickly.
Setting up your Experian Smart Business Report is free. They are used by a wide variety of lenders to make decisions.
The majority of commercial banks, leasing companies, business credit cards, and many trade vendors report activity and trade lines to Experian.
If you can't find a file for your business yet, one will be available within 30 days of the first payment reported.
There's a very detailed FAQ on the Experian Smart Business Report here.
Creditsafe business credit file
Creditsafe is the largest global business credit agency, but new to the U.S. scene.
Regardless, over 10,000 creditors and lenders already rely on them for evaluating business loan qualification. There's a very strong chance your lender will look at this report as well.
Unlike other bureaus, Creditsafe also provides credit limit recommendations to lenders. That is they recommend the total amount of outstanding credit that your business should have at anytime.
Dun & Bradstreet DUNS number and open file
D&B tends to be considered the go-to source for Net-Terms credit reporting data. Which is great if you have access to trade lines with vendors.
D&B won't issue a DUNS# or D&B rating until you interact with them directly. You'll need to first request a DUNS#, the free path takes 15-30 days for them to setup.
You can also sign up for their credit builder product to expedite everything, and get access to your PAYDEX score as an added bonus.
You'll have another score to monitor here. Unlike the other credit bureaus, D&B uses a PAYDEX score to provide instant creditworthiness feedback to lenders.
A PAYDEX score of 75 is considered, by many, the minimum to be qualified for the best business financing opportunities.
If you just pay all of your business trade and credit lines on-time, that is within the terms established for each line, you will get a score of 80.
PAYDEX rewards you for paying early, averaging payments 30 days earlier than required is the only way to reach a perfect 100. It's also worth noting that each credit line is weighted, so frequent big payments will carry more weight than infrequent small payments.
Equifax Small Business credit file
Most U.S. banks and business credit cards underwritten by banks report to Equifax. Equifax is typically slower to open a file on your business than other bureaus.
Like the other bureaus, your Equifax Small Business Credit Risk Score is determined heavily by timely payments. Equifax is not very open about all of the factors that go into the score though, so it is a bit of a black box.
The score itself is on a scale of 101-816, with higher equal to less credit risk.
The Equifax report also provides lenders with a Business Failure Risk Score. On a scale of 1000-1880, with higher scores equal to lower risk. This score is paired with a "class", 1-5 with 5 being most risky, and a percentile.
Money in the bank
Your business banking history is tracked, scored, and relevant to your creditworthiness. It's commonly called a "bank rating" and you're graded on a graduated scale.
The bank rating scale is based on the average balance in your account for the last three months, and it takes into consideration any adverse history such as bounced checks.
Lenders want to see that you have enough cash on hand to service debt, that you're using it responsibly, and that you're keeping a cushion.
A "low 5" rating is usually what lenders want to see when you're applying for a loan. To be in that range, you need at least $10,000 in the bank on average for three months and no adverse activity on the account.
This tends to be a non-negotiable condition for lenders.
A line of credit from a vendor
Well, you actually should aim for at least 5. That seems to be the magic number to establish your business and ease lenders' concerns.
A line of credit from a vendor is basically the ability to pay a vendor on Net terms, usually 15, 30, 60, or 90 days. That means, you get something from the vendor and the net balance is due X many days after you receive the vendors service or product.
It's actually pretty easy to set these up for common business purposes. Frankly, you might have some already and not even know it. Many business supply companies, like Grainger, will extend small trade lines of up to $1000 to any real business with an EIN and a DUNS#.
The key factor to remember here is that these are only impactful if use the trade line consistently, monthly, and pay it down in full each month...on-time.
Business credit cards
Revolving credit accounts are a powerful tool to build your business credit rating, just like they are with personal credit.
Once you have your credit files open and vendor trade lines reporting, you can begin applying for business credit cards.
The business credit cards you want are just those that report to your business credit profile, and are in no way linked to your personal credit file.
Not all business credit cards will report to just your business credit profile, so be selective. Some may require a personal guarantee, which is OK to provide in the beginning.
A business loan from a bank
You might be asking yourself, "do I need a loan to get a loan?". The answer is no, you don't.
BUT, if you want to expedite building your business credit history AND increase the odds of securing a more substantial loan amount with better terms, then this is important.
It's not a catch-22, you can get a low-value business loan pretty easily when it's secured. That means you place a deposit with the bank in an interest bearing account like a Certificate of Deposit, in turn the bank will give you a loan for the exact value of the deposit.
You pay it off, then you close the CD and recover your payments. The net cost to you is just the difference in interest rates between what you earn on the CD and what you pay on the loan. Secured loans tend to carry low interest rates as well.
To take full advantage the loan has to be in your business name and using your business EIN, with payments coming from your business bank account. Early payments help expedite your credit building as well.
If you think this feels like cheating, it's not. Secured business loans are common, here's an offer page at Bank of America.
There are lots of legitimate reasons for a secured loan, and building your business credit is one of them.
Wrapping It All Up
Taking the above steps will get you on track to secure a more substantial business loan within as little as 1 year. In the next article, we'll discuss a Small Business Administration specific requirement, the SBA business plan.