Often, it takes deep pockets to start and scale a business, but many budding entrepreneurs are cash-strapped with limited savings.
When venture capitalists and angel investors aren’t an option, there’s another door: borrowing from a lender.
But how do you convince a bank to lend to you when you’re the new business on the block? The key is establishing business credit, which is crucial to building credibility with lenders and getting funding as a founder.
What is business credit?
Business credit is similar to personal credit, except it’s developed using your company’s financial records instead of your own. By building your business credit, you can apply for business loans and lines of credit to use for company expenses, such as:
- Renting or buying office space
- Buying equipment
- Paying employees
- Purchasing inventory
- Scores 1-10: High Risk
- Scores 11-25: High to Medium Risk
- Scores 26-50: Medium Risk
- Scores 51-75: Low to Medium Risk
- Scores 76-100: Low Risk
Why separate your personal and business credit histories?
Having separate business credit safeguards your personal finances and assets from the fallout of your business. For instance, filing for bankruptcy or falling behind on business loans won’t impact your personal credit score or place your home and other assets at risk of seizure.
It’s also advantageous if you have poor personal credit — instead of relying on your credit score, you can establish and build business credit to qualify for loans.
It’s a faster and more affordable option, especially if you have a lot of personal debt (e.g., student loans, medical bills, mortgage) to pay off.
What are the benefits of having good business credit?
Aside from increasing your odds of getting approved for business loans and credit lines, good business credit can enable you to:
- Reduce interest rates on business loans
- Order products or services from vendors without needing to prepay
- Lower business insurance rates
How long does it take to build business credit?
Establishing business credit takes time, especially if you’re starting from scratch. How long depends on what financing options you choose (e.g., loans vs. revolving credit lines), and how well you manage your money.
For example, you can spend six months to a year paying your vendors on time and building relationships, then ask for a credit line. Then after another six months to a year of doing that, you can use your vendor as a reference to secure a business credit card or loan with a bank.
It can therefore take up to two years to establish credit for your business.
Note that paying off business loans too soon can stunt business credit growth since on-time payments are a factor in calculating your business credit rating.
So if you pay off a 12-month loan in three months, you only have three on-time payments instead of twelve — unless you take out another loan after. The more on-time payments you make, the more points you get over time.
How to establish business credit for the first time
To establish business credit, you need to apply for business loans and credit cards that don’t require a high score or extensive credit history.
Potential options include:
- Secured business loans (requires collateral, such as business or personal property)
- Secured business credit cards (requires a deposit — some are refundable after a specific time frame of on-time payments)
- Online lenders (typically have lower standards for approval)
- Finance companies (usually require collateral)
Many small business owners lean toward online lenders because of the high approval odds.
The next best options are small banks and finance companies, which include non-bank lenders such as mortgage companies, equipment dealers, insurance companies, and auto finance companies.
Whichever route you take, use the following steps to begin establishing business credit.
Register your business
The first step to establishing business credit is to create a separate entity. The type of business structure you choose is up to you. Options include:
- Limited liability corporation (LLC)
- C corporation
- S corporation
- Limited liability partnership (LLP)
Visit your county clerk’s office or website to begin the business registration process.
Apply for an EIN
After registering your business, use your company name to apply for an employer identification number (EIN). The IRS uses this to track your business’s finances for tax purposes. It’s not required for businesses that don’t have employees, such as sole proprietors, partnerships, or single-owner LLCs.
However, it’s still good to have, since you can use your EIN instead of your Social Security number when applying for business loans and credit cards. It’s a way to build your business credit without worrying about poor personal credit impacting approval odds.
Open a business bank account
Keeping your personal and business finances separate is vital — banks will ask to see your business profits and losses (P&L), which shouldn’t include personal income or expenses.
“The easiest way to establish credit is to open a bank account for your business and apply for a business credit card,” advises Richard Clews, founder of online retailer Pants and Socks.
“Another option that I pursued was to take out a credit-building loan from my bank. Paying the loan off in six months and repeating the process also gave me two solid scores and more payment history. After two years, I built a good business line of credit."
Consider opening a business checking account at the same bank you have a personal account since you already have a relationship with them. This may make it easier to get business lines of credit and loans down the road.
Apply for a business DUNS number
Now, it's time to submit your business information (e.g., address, business name, CEO/owner, legal structure) to the three business credit bureaus. To do this, you must apply for a DUNS (Data Universal Number System) number. This is what local and international suppliers and creditors use to determine the creditworthiness of businesses.
After submitting your application, you should receive the number within 30 days.
Apply for a business loan, credit card, or line of credit
Secured credit cards and loans are a great start because you won’t need a high credit score or lengthy credit history. In fact, these products are mostly targeted at businesses with poor credit or no credit.
Check with your credit union or bank to see what they offer. If their options are not appealing, look into applying with a financing company or online lender.
Another route is to use the relationship you have with your personal bank. If you have personal credit cards or loans in good standing with your bank, then they may open a business line of credit for your company.
Jeff Neal, founder of pet feed store CritterFam, shares that he and his co-founders initially expensed their overhead on their personal credit cards.
“We did this for about a year until we could convince our credit card company to offer us a business credit card. The business credit card gave us a larger balance, but we were disciplined and paid off that balance monthly. After we did this for another year, we approached our bank for a business line of credit, which we’ve been using ever since."
Open trade lines with your vendors and suppliers
Large financial institutions aren’t the only option for establishing business credit. If you have relationships with third-party vendors and suppliers, ask them for lines of credit.
This will allow you to order inventory, supplies, or other goods with the promise to pay in the future. This may be on a NET 30 agreement, which means you pay your invoice within 30 days.
“The easiest way to establish business credit is with your vendors,” says Steve Mascarin, CEO of Taunton Village Dental. “Vendors that allow you to go on a 30-day payment system will help you establish credit. Most vendors will do it but be sure to follow through or have it automatically deducted. Then, you can use them for references at a bank to get a credit card or line of credit.”
But it’s ideal to build a relationship with your vendors beforehand.
For example, Steven MacDonald, managing director of Scotlight Direct, created pro format accounts (where you pay upfront) with suppliers. Then he also opened a business credit card using a personal guarantee.
As MacDonald placed orders for more stock and established relationships with companies, he moved to small credit accounts (with low credit limits), which grew with his business. His first credit line was opened after 12 months of trading and paying on a pro forma basis.
“Communication and honesty are essential. We continued building relationships with our suppliers and bank and were very open and transparent with our business. We almost always paid on time, and when we couldn’t in the earlier trading years, we were always first to open up a line of communication to resolve any cash flow issues resulting in payment delays. We got our credit from manufacturers, importers, and banks.”
How to establish business credit without a personal guarantee
Growing and expanding your ventures is an exciting time. But the risk of losing personal assets if things go sideways is frightening, especially if you’re borrowing to keep your business above water.
Lenders that require a personal guarantee are asking businesses to put personal assets on the line, such as real estate, vehicles, and bank accounts. This allows them to take personal collateral should you default on repaying your loan or line of credit — a common ask for new businesses.
One option for establishing credit without a personal guarantee: Agree to a loan or credit card that comes with a much higher interest rate.
In this scenario, the lender or creditor won’t require a personal guarantee, since you’re paying more over time for the money you borrow.
Another option is to apply for a secured business credit card. Some require you to pay a deposit, which is what you’re borrowing against each time you use your credit card. Others may ask for a personal guarantee, or use your cash flow to determine your credibility and credit limit. After about six months, you can ask for a credit limit increase without additional deposits.
One day, you may even get your deposit back, turning your secured credit card into an unsecured credit card. This will open doors to more unsecured business credit and loan offers.