Though many small business owners may realize the importance of having a strong business credit profile, they may be at a loss when it comes to building it up. Much of the confusion can be traced to numerous misconceptions and conflicting messages often propagated by the credit industry itself.
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The truth about establishing a good credit report for your new business is that it involves much more than creating a separate business credit profile, paying bills on time, or having a business credit card. Below is an explanation of what a business credit profile is, how to build it, and a breakdown of some common misconceptions.
What is a Business Credit Profile?
A credit report on your business is like a snapshot of how you manage your financial obligations. Banks, utilities providers, credit card companies, as well as numerous vendors and business service providers will report financial information about your business to the major credit reporting agencies: D&B, Experian, Equifax and TransUnion. These credit agencies then compile the data into standardized reports and scores.
So what exactly can you expect to find on your credit report? In addition to basic company information such as annual sales, years in business, number of employees and EIN numbers, you will be able to see information about the company’s owners as well as which vendors and service providers your company is working with. You can also expect to see a rundown of any outstanding balances, credit lines or business loans, as well as your overall payment habits and trends. Some credit reports may additionally compare your financial performance with industry standards and include public records such as liens, judgments or bankruptcies.
The final and in some ways most crucial part of your business credit report is the risk assessment in the form of a credit score. Much like a consumer credit number, this score is based on several factors, such as how the company pays its financial obligations, the nature and structure of the company’s debt, and the debt-to-income ratio.
Whether you realize it or not, chances are that once your business is up and running it will start generating data that can be accessed by a third party. To find out if your business already has a credit profile, you can freely search the business sections of the credit reporting agency’s websites. If you want a detailed report, however, you may have to pay a fee.
Why is a Good Business Credit Profile Important?
The most important reason why it pays the maintain a good credit report on your business is that it will be taken as authentic sign of creditworthiness and financial stability. This is particularly important if you will be entering into business partnerships, working with vendors, attracting investors, or have in mind to eventually sell the business. Moreover, you can expect that banks and commercial lenders will consult your credit report before extending any credit or financing to your business.
What are the Differences Between the Credit Bureaus?
Many don’t realize this, but each of the four major credit reporting agencies serve slightly different needs and typically draw the attention and activity of distinct groups of businesses and individuals. Here is a brief rundown:
- Dun and Bradstreet- Dun and Bradstreet (D&B) is probably the most well known credit reporting agency. D&B has algorithms that compile all the information they have on a particular company into a single score called a Paydex. Paydex scores range from 1 to 100, with 75-80 being considered a good score. D&B primarily deals with vendors that extend credit to their customers and as such is the go-to place for vendor companies trying to determine if a particular business poses a potential credit risk.
- Equifax- Equifax draws the attention of most major banks and other commercial lenders. Banks that report the payment history on their business loans, generally send this information to Equifax. Likewise, if a bank is trying to find out if it should lend to a particular business, it will check out the business’ Equifax credit profile. A new business owner looking to build up an Equifax number should perhaps try to get a bank loan secured with collateral or in limited cases, rely on personal credit for the business loan and then try to get the bank to report payments in the business’ name.
- Experian- Experian business credit reports are primarily used by business credit card companies. Some credit card vendors report to D&B, though. So you should check with a prospective credit card company beforehand to see which agency (or agencies) it reports to.
- TransUnion- TransUnion is the credit reporting agency that is perhaps used the least, and its reporting system and activity are primarily used by consumers or businesses considering extending consumer credit.
What Can You Do to Build Up the Credit Profile in Your Startup?
As you go about developing your new business, there are several steps you can take to get your business’ credit profile up and running:
Make sure your personal and business credit information and profile are as separate as they can be. Entrepreneurs looking to run a sole proprietorship or finance their businesses with their own credit and assets, often mix their personal and business financial information and credit profiles. This can be a costly mistake, since your personal credit profile will then directly effect your business credit, and visa versa. Make sure that business and personal accounts are completely separate. You should also try to get a business credit card that does not report to your personal credit profile nor rely on a personal guarantee (see below). Finally, many business financial experts recommend registering a small business as an LLC. (For more information on LLC’s and the other business structures, see my previous post on setting up a legal business entity.)
Seek out transactions that will improve your credit score. Specifically seek out those arrangements that will build your business’ reputation. You can find out which businesses report to the credit agencies and make it a point to do business with them and to keep your payments on time. As mentioned above, you can also try to get some form of secured financing with a bank to build your Equifax score. The credit reporting agencies themselves also offer a number of credit-building services for a fee.
Make good cash flow management a priority. Make it a priority to pay your bills on time. You can help your company do this by setting up automatic bill payments and by having a good accounting system in place that allows you to consistently monitor your accounts and overall cash flow with financial reporting.
Make use of a small amount of your available credit. One factor that significantly affects a credit score is the debt-to-available credit ratio. Most money managers and financial experts recommend staying below 30% or a maximum 50% of your credit limit.
Monitor your business credit profiles. If your personal and consumer credit profiles overlap in some way, then you should maker sure to take advantage of a free annual report from all three major credit bureaus (with the exception of D&B). If you have a completely separate business credit profile, then you’ll have to pay a fee. When you get these reports check them carefully for errors. Alternatively, you can enroll in a small business credit report monitoring program For a fee, a monitoring program usually gives unlimited access to a company’s own credit report but also sends out notifications whenever there is activity.
What are Some Common Misconceptions About Business Credit?
There is a lot of misinformation regarding business credit reporting. Here are a few of the biggies:
A Separate Business Credit Profile Can Still Be Linked to Personal Credit. Business owners running either a sole proprietorship or a partnership are still held liable for their company’s debts, and if such a business is having financial difficulty, chances are that their personal credit histories will be affected. Moreover, lenders often consider the personal credit history of the business owners (especially if the business is relatively new) when deciding whether or not to extend credit.
Not All Transactions Will Effect a Business’ Credit Score. Though banks, credit card companies, utility, and phone companies generally report billing and credit information to the major credit bureaus, the same is not true for all businesses. This means that a business owner can spend years faithfully paying off vendors, suppliers, and distributors, etc and it will not affect the business’ credit score one bit.
Not all Business Credit Cards are Created Equal. Business owners in search of a credit card may be surprised to know that many so-called business credit cards are little more than a glorified personal credit card. Not only are business owners held personally liable for the debt incurred, but all transactions are reported on their personal credit profiles, and their personal debt-to-credit limit ratios are affected. Be aware that a true business credit card will report financial information solely to the business’ credit profile and the business owner will not be held personally liable for the debts incurred. Anyone considering a business credit card should be sure to read the fine print carefully.
Errors on Business Credit Reports are Hard to Fix. Many small business owners are unaware of the fact that there are currently no laws protecting businesses from the credit bureaus. This means that should a business owner find an error on the business’ credit report, the credit bureaus are under no obligation to change the information. If you are keeping clear and accurate financial records then if a dispute comes up there is sufficient evidence to back up your claim and a resolution can be carried out as quickly as possible.
Gary Barzel is the manager of business development for Fastupfront. Fastupfront offers business loan alternatives for established small businesses in need of working capital.