One of the first things that I advise new business owners to do after they have established a legal business entity is to start building business credit. Business credit is just as important as personal credit as it serves the same purpose, which is establishing financial credibility and accountability. In the same way that an individual is required to have a decent and substantial credit history to borrow money for purchasing a car, home, etc., a business needs the same type of credit history to get loans for certain business expenses. This is usually not a concern in the beginning, but it can be a major factor as a business expands and grows.
Even if you have the start-up capital to finance your business venture, you may need to borrow money in the future. Banks and other financial institutions consider business credit history as a major factor when deciding on credit and loan approval, limits, and interest rates. This is why it is important to begin establishing business credit as soon as you have all the necessary qualifications to apply for business credit cards, loans, and lines of credit.
Business Credit Cards
Business credit cards operate in much the same way as personal credit cards. In fact, many of the major credit card companies use your personal credit history when they decide to issue you a business credit card. However once they issue a business credit card, the card activity is recorded as part of the business credit history, and in some cases as part of your personal credit history too.
In order to apply for a business credit card you will need to apply under the legal name of the business using the employer identification number, business structure information, business address, and business and personal financial data, etc. As mentioned earlier, you will also need to use your social security number since your personal credit history will be used to secure the business credit card. This is why it is not necessary for you to have an established scream of revenue in order to get approved for a business credit card.
There are several tiers of business credit cards that you may qualify for depending on your personal credit history and score. Many credit card companies issue secured, standard, and premium line business cards to start-up companies.
Secured credit cards are one of the best options for entrepreneurs who have little to no credit history or fair credit scores. This type of credit card requires the holder to secure the credit card with a cash deposit of variable amounts. The cash deposit amount is generally the credit card limit, which means that you are effectively using your own money to establish credit. Even though you are using your own money, the credit card company still reports your activity to credit reporting bureaus which allows you to build or rebuild credit.
Standard business cards are great for entrepreneurs with good to very good credit scores. These borrowers can generally get a standard business credit card limit of about $2,500 to $5,000 depending on their credit score. Premium credit cards are generally reserved for individuals with exceptional credit scores. These cards come with higher credit limits and optimal reward systems. Individuals with exceptional credit scores can usually obtain standard or premium credit card limits of $10,000 or more.
In addition to establishing business credit, business credit cards can help you keep business and personal expenses separate, increase your purchasing power, and take advantage of nifty reward programs.
Small Business Loans
Business owners usually only consider business loans when they have a direct need for a loan. This is generally a good strategy. It is best not to borrow money unless you need it for a specific purpose. And, if you need to it is vital that you pay the loan back according to the payment terms. Doing so will help you maintain and improve a good business credit score.
I typically don’t advocate loans for the mere sake of borrowing money. However, for the sake of establishing business credit a small business loan may be a viable option. If you think that you will have a need for larger business loans in the future it is best to start building your loan borrowing history by taking out smaller business loans even if you don’t have a specific need for one.
Loans may reflect differently on your business credit report than credit cards based on utilization and payment habits. Credit card usage can be variable and are considered revolving debt on credit reports, which means that your business credit score may fluctuate often depending on your credit card usage. On the other hand, loans are a great way to establish a more stable business credit history.
The benefit of business loans over credit cards is that interest rates tend to be lower and loan amounts can be much higher. Repayment terms are fixed and you don’t have to worry about variable interest or other fees often associated with credit cards.
For these reasons, business loans are generally more difficult to get approved. You may need collateral, a co-signer, or other guarantors to secure a business loan. This is why I recommend starting with smaller loans in the beginning phase of your business. Doing so will allow you to develop a relationship with your lender and establish your business loan borrowing history.
Business Line of Credit
Establishing a business line of credit is another way to build business credit. Small business lines of credit are not as well known as business credit cards and loans. However, they are just as viable of an option as credit cards and loans. In fact, a line of credit shares similar aspects of both options but operates more like a credit card than a loan in many regards.
Most business lines of credit are unsecured like credit cards though they tend to have higher limits similar to loans. Credit limits for lines of credit are usually between $10,000 to $100,000 – anything over this threshold must be secured. In this way, a business line of credit is generally easier to qualify for than a business loan because it doesn’t require the use of a guarantor, in most instances.
A business line of credit is considered revolving debt because borrowers only pay interest on the amount borrowed. For instance, you may qualify for a $50,000 line of credit but only borrow $10,000 from the line of credit initially. In this case, you will only pay interest on the $10,000 though the $50,000 is still available to you. This is the same way a credit card works.
It is important to note that a business typically needs to be in operation for a longer time frame to qualify for a line of credit. Additionally, repayment terms may be shorter or more frequent when borrowing from a line of credit. Some lenders require weekly repayment and some may require six-month or shorter repayment terms. As with credit cards and loans, line of credit utilization is reported to business credit bureaus and is used to determine business credit scores.
Interest rates on business lines of credit tend to be lower than rates and fees associated with credit cards. Credit limits are typically higher than business credit cards and approval is generally easier to obtain than with business loans.
As with personal credit, it is very important to borrow wisely and repay debt in a timely manner. As mentioned throughout this post, business credit card, loan, and line of credit activity is reported to credit bureaus. The ultimate goal is to ensure that you only borrow what you need and that you repay your debt in accordance with the terms and conditions of the creditor. Following these guidelines will help you build a strong credit history for future borrowing needs.