How Your Personal Credit Affects Business Credit
As a small business owner, you’ve likely poured your heart, soul, and personal savings into making your entrepreneurial dream a reality. So it may come as a surprise that your personal finances – including your all-important credit score – can directly impact your ability to access affordable funding and growth opportunities for your business. Knowing that personal credit affects business credit is necessary for awareness, however, it’s necessary to understand common examples to feel empowered to take action.
The Link Between Personal and Business Credit
For most small businesses, especially newly launched ones, the owner’s personal credit profile is tightly intertwined with the business’s creditworthiness. Here’s why:
Many lenders view personal credit as a snapshot of how responsibly you manage your finances. If you have a poor personal credit score, reflecting late payments, maxed out credit cards, or other red flags, the lender may see this as an omen for how you’ll handle business debts too.
“We routinely pull personal credit reports for any small business loan applicants,” says Steve Williams, Loan Officer at Summit Reach Credit Union. “A strong personal credit score shows discipline and increases our confidence to lend to that owner’s business.”
In fact, for smaller loans under $100,000, some banks focus solely on the owner’s personal credit credentials rather than any formal business credit history which is often lacking for startups.
Additionally, most traditional and SBA-backed small business loan programs technically require an owner’s personal guarantee. This makes you personally liable for repaying the debt, even if your business stumbles.
In essence, lenders see your personal and business finances as one and the same, especially for sole proprietors or new companies without years of credit history to stand on.
Potential Credit Challenges for Small Businesses
Having lousy personal credit can create very real barriers and headwinds for small business owners. Some common impacts include:
Difficulty Qualifying for Loans/Credit Lines
Most lenders have minimum personal credit score requirements to approve small business financing requests. Anything under 680-700 may automatically disqualify you from loan consideration at some banks.
“One of my clients was declined for a $20,000 line of credit because the owner had a 590 personal score stemming from some prior collection accounts,” recalls Robert Wilson, a small business banker in Phoenix. “It was a huge letdown as he needed that liquidity to pay staff.”
Higher Rates and Fees
If approved despite impaired credit, your interest rate and fees will likely be elevated. Lenders view you as a greater default risk and price your debt accordingly.
One New York-based small business paid $20,000 more in interest after being quoted a 12% rate versus the 8% rate they hoped for due to the owner’s 630 credit score. Over 20 years, that’s $1,000 in extra interest costs annually.
Lower Borrowing Limits
Some lenders may simply restrict the maximum loan size based on credit scores. So even if you qualify, you may be approved for less capital than requested. This could stunt growth plans if you only receive partial project funding.
For example, one business owner planned to use a $150,000 loan to open a second location. But due to a 665 personal credit score, the bank capped her loan at $100,000 – leaving her well short of the needed capital investment.
Clearly, having strong personal credit scores can grease the wheels for small business financing approval, affordable rates, and higher borrowing potential. So how does an owner address personal credit issues that could impact their business?
Building Separate Business Credit
The ideal scenario is to completely decouple your personal credit from your business’s creditworthiness. This insulates your ability to access capital for the company from any fluctuations with personal finances over time.
To do this, you’ll need to build credit history for your business entity that is entirely separate from your consumer credit profile. This allows lenders to evaluate the business’s risk independently.
Some key steps include:
- Incorporating your business to formalize it as a legal entity
- Obtaining business credit cards and loans
- Establishing trade lines with vendors/suppliers who report payment history to business credit bureaus
- Maintaining perfect payment history as a business over several years
While challenging for a new business, establishing separate credit is recommended to create long-term financing flexibility. It protects both your personal and business credit ratings from cross-contamination.
Repairing Personal Credit for Your Business
In the meantime, maintaining strong personal credit scores remains crucial for most small business owners – especially in the first few years of operating. Here are some tips for strategically repairing personal credit to improve loan approval odds:
- Understand Your Credit Report – The first step is ordering your credit reports from the three major consumer bureaus (Experian, Equifax, TransUnion) to identify any errors or negative items severely impacting your scores. You can get free reports annually from www.annualcreditreport.com.
- Dispute Inaccuracies – If you spot any mistakes on your reports, like accounts wrongly showing late payments or inaccurate balances/credit limits, be sure to dispute these errors with the relevant bureaus and creditors in writing. Removing inaccurate data can quickly improve your scores.
- Reduce Credit Balances – Having revolving credit utilization above 30% can significantly ding your scores. Focus on paying down credit card balances each month to reduce utilization rates. The lower these are, the better for your credit rating.
- Limit New Credit Checks – Applying for multiple new loans or credit cards in a condensed span can make you appear cash-strapped. Follow the “AAOA method” – Apply for one loan. After approval/denial, Apply again. It spaces out hard inquiries to minimize impact.
- Build Positive History – Finally, making consistent on-time minimum payments each month on all remaining credit lines is crucial. As you build more positive payment history, your scores will gradually rise from the fresh data outweighing the past delinquencies.
For extra assistance, you can hire a professional credit repair firm. Services like Ovation Credit Repair request bureau audits to update your file with any positive accounts left off initially. This can expedite boosting FICO scores.
However, be wary of any companies promising to remove legitimate negative entries through manipulative or illegal tactics. Repairing credit legitimately takes time and strategic payments.
Protecting Your Credit Long-Term
Regardless if your business grows to separate business credit or not, it’s wise to implement habits to sustain personal credit health. Some best practices include:
- Setting payment reminders/automations to avoid any missed bills
- Getting free credit monitoring to track scores/report changes
- Only applying for new credit as legitimately needed
- Keeping credit utilization under 30% per card/loan
- Regularly checking reports to dispute errors or fraud
By remaining vigilant about your personal finances, you ensure credit scores are optimized whenever you need to approach lenders about financing for your growing business. Strong personal and business credit profiles position your company for sustainable long-term success.
Why Small Business Owners Need Good Credit
It’s not enough to know that personal credit affects business credit. Knowing how to create strong personal and business credit unlocks crucial access to affordable financing that can power growth opportunities and working capital needs. Here are some common reasons small business owners require good credit:
Funding Expansion Plans
Let’s say you own a successful restaurant and want to open a second location. Renovation costs, equipment, inventory, and marketing could easily require $500,000 in upfront capital. With poor credit, you may only qualify for high-interest short-term loans capped at $100,000 – falling far short of your funding needs. But good credit could land you a low 6% interest rate SBA loan for the full $500,000 to execute your expansion vision.
Purchasing Inventory/Equipment
Retailers often need lines of credit to purchase inventory in bulk from suppliers and manufacturers. Good credit increases your borrowing limit, allowing you to order more products to meet demand. Similarly, contractors may need equipment financing, where credit issues mean getting stuck with older, less productive machinery.
Managing Cash Flow Gaps
Inconsistent cash flow is one of the biggest challenges for small businesses, especially startups. Having a business line of credit with a low interest rate thanks to good credit scores provides a cash flow safety net. You can borrow affordably to cover operating expenses and payroll during lean months before your accounts receivable picks back up.
Commercial Real Estate
If you need to purchase commercial real estate for your business’s office, storefront, or industrial space, lenders will scrutinize both your personal and business credit reports. A high down payment and interest rate may be required if your credit score is below their standards.
The bottom line is that strong credit profiles make small businesses appear less risky to lenders, allowing owners to access lower interest rates and higher borrowing amounts. This empowers you to strategically invest, manage cash flow, and grow the business rather than being handicapped by limitations from poor credit.
The Bottom Line
As a small business owner, being proactive about personal credit management should remain a top priority – especially in the early years before you can establish business credit history. Your personal scores, for better or worse, influence interest rates and approval odds on critical growth capital from lenders.
By following smart credit practices over time, you maximize affordable access to the funding runway needed to take your entrepreneurial dreams to new heights. This includes:
- Checking your credit reports regularly and disputing any errors
- Making all minimum payments on time every billing cycle
- Keeping credit utilization low by paying down balances
- Only applying for new credit when truly needed
- Eventually building business credit independent of personal
Whether you’re just getting started or have an established business, responsible credit habits can quite literally open the door to more affordable financing opportunities. Strong personal and business credit profiles position your company for sustainable long-term success by enabling you to invest in growth when the time is right. So protect those credit scores as you would any key business asset!