How Do Credit Scores Affect Business Funding?

Learn how credit scores determine who qualifies for a loan, at what interest rate, and what credit limits.

Credit scores are an integral part of the financial world. For individuals, these scores determine the ease with which one can access credit, the amount of credit one can receive, the interest rates on loans, and even the ability to rent housing or gain employment in some industries. High credit scores indicate lower risk for lenders, often resulting in better interest rates and higher credit limits.

For businesses, credit scores hold significant importance for several reasons:

Access to Financing: A strong business credit score opens up a plethora of financing options. This is critical for businesses seeking loans to start up, expand, buy inventory, or manage cash flow fluctuations. A good credit score can make the process smoother and can secure lower interest rates, which is financially beneficial for the business.
Supplier Terms: Businesses with a strong credit score can negotiate favorable payment terms with suppliers, such as longer payment periods or discounts for early payments. This improves cash flow management and can reduce the cost of goods sold.
Company Image: A robust credit score enhances the reputation of the business. It signals to clients, suppliers, and partners that the company is stable and a reliable party for doing business.
Expansion and Growth: Companies often need to access larger lines of credit or additional financing as they grow. A strong credit score can facilitate this, enabling the business to invest in new opportunities and resources.
Savings: Over time, lower interest rates and better financing terms can result in significant cost savings for the business, improving overall profitability.

Differences Between Personal and Business Credit Scores

While personal credit scores measure an individual’s creditworthiness, business credit scores assess the creditworthiness of a business entity. Although similar factors influence both, there are distinct differences.

Personal credit scores, scaled from 300 to 850, are based on personal financial history, debts, and payment records. Good personal credit is essential for business owners, especially when a business lacks an established credit history.

Business credit scores typically range from 0 to 100, as used by Dun & Bradstreet, and are based on various data points including payment history, credit utilization, business size, and industry. Scores of 45 and above considered low- to medium-risk by lenders. The FICO LiquidCredit Small Business Scoring Service score ranges from 0 to 300, and a small business must score at least 140 to pass the pre-screening process for the most popular SBA 7(a) loans. Higher scores generally translate to better chances of loan approval and more favorable loan terms. It’s important to note that different lenders may have varying thresholds for what they consider to be a good business credit score.

Factors That Influence Credit Scores

Payment History

Timely payments positively impact a credit score, demonstrating reliability. Late payments, defaults, foreclosures, or bankruptcies have a negative effect, suggesting a higher lending risk.

Credit Utilization

Representing the ratio of current revolving debt to the total available credit limit, low credit utilization is viewed positively, indicating a consumer doesn’t over-rely on credit. High utilization can hurt credit scores.

Length of Credit History

Long-term credit accounts are seen favorably because they provide a longer track record of financial behavior. Newly established credit histories lack depth, potentially harming scores.

Types of Credit in Use

A well-balanced mix of credit accounts, including installment loans and revolving credit, can illustrate that an individual can manage different types of credit responsibly.

New Credit

Opening several new credit accounts over a short period can decrease credit scores. Each credit application can result in a hard inquiry, which may have a small and often short-lived negative impact.

How Do Credit Scores Affect Business Funding?

Strong personal credit scores can help business owners in the initial stages secure funding, as lenders often look at the personal credit of the owners due to the business’s lack of credit history. High personal scores suggest reliability and may result in better loan offers.

As businesses develop, establishing and maintaining a healthy business credit score becomes increasingly critical. A strong business credit score can unlock access to larger loans, better interest rates, more favorable repayment terms, and may reduce the need to personally guarantee business debts.

The perceived risk reflected by the credit scores can have ramifications for business operations, growth opportunities, and overall financial stability. A poor credit score may hinder a business’s ability to receive funding, leading to challenges in managing cash flow, resulting in stunted growth or the inability to capitalize on market opportunities.

Credit scores are a linchpin in the business funding process. They impact loan application decisions and determine the cost of capital – a crucial element for business growth and sustainability. Understanding and proactively managing personal and business credit scores can, therefore, be of immense benefit to entrepreneurs and small business owners.

Achieving and maintaining high credit scores require a strategic approach to financial management, both personally and in business. Those who master the intricacies of credit scoring can navigate the challenges of securing business funding more successfully, thereby positioning themselves for greater financial success and stability.

Interest Rates and Loan Terms

When assessing credit scores for business funding, lenders are principally concerned with the likelihood of timely repayments. A high credit score may lead to more favorable interest rates because it indicates to lenders that the risk of lending to the business is minimal. Consequently, as the business poses a lower risk, lenders might offer lower interest rates, translating into lower borrowing costs.

Conversely, if a business has a poor credit score, lenders may deem it a higher-risk entity and may only offer loans at higher interest rates to hedge against the heightened risk of default. Additionally, a low credit score can lead to stricter loan terms, including shorter repayment schedules, higher down payments, requirements for collateral, more stringent covenants, and sometimes, even loan denial.

Businesses should strive for high credit scores as it not only increases the probability of loan approval but also directly influences the interest rates and terms which can significantly impact the total cost of borrowing, cash flow implications, and overall financial health of the business.

Steps to Establish Business Credit

Building a strong business credit profile is critical to securing funding and achieving long-term success. Establishing business credit involves several steps, beginning with setting up your business properly.

Choose the Right Business Structure: Opt for a formal business structure like a limited liability company (LLC) or corporation. This creates a legal separation between personal and business finances, which is crucial for building business credit.
Obtain an Employer Identification Number (EIN): Apply for an EIN with the Internal Revenue Service. It’s used to identify your business entity and is needed to open a business bank account and file taxes.
Open a Business Bank Account: With your EIN, open a checking account under the business’s name. Use this account to handle all business financial transactions to maintain a clear distinction from personal finances.
Get a D-U-N-S Number: Register for a D-U-N-S Number from Dun & Bradstreet. It’s essential for creating your business credit file and is often required by lenders and suppliers.
Establish Credit with Vendors and Suppliers: Form relationships with multiple vendors or suppliers that report to the major credit bureaus. Ensure that you make timely payments to create a history of responsible credit management.
Apply for a Business Credit Card: Secure a credit card in the name of your business. Use it responsibly and pay off the balance in full, or at least make timely minimum payments.
Monitor Your Credit Reports: Regularly check your credit reports from major business credit bureaus – Dun & Bradstreet, Equifax Business, and Experian Business. This will help you track your business credit history and correct any inaccuracies.
Pay Bills On Time: Always pay your business-related bills on time. Late payments can significantly harm your business credit score.

Establishing credit for a business is akin to building personal credit but operates under a different set of rules. Not having established business credit can limit your funding options as business lenders, insurance companies, and potential partners often check credit scores before engaging in business relations.

How to Improve Business Credit Scores

Improving business credit scores is an ongoing process that requires discipline and planning.

Maintain On-time Payment History: Demonstrating a history of on-time payments is a primary factor in credit scoring models. Consistently paying creditors by or before the due date will improve your business credit score.
Increase Credit Availability: Increase lines of credit with lenders and vendors. This doesn’t mean you should use all available credit; instead, it demonstrates that your business can manage more credit responsibly.
Keep Debt-to-credit Ratio Low: Work on lowering the amounts owed concerning your credit limit. A high debt-to-credit utilization ratio can signal that your business is overextended and may negatively influence lenders.
Regularly Update Business Information: Ensure that your business information on your credit reports is current and accurate. This includes updating operational status, address, or business activities.
Dispute Errors on Credit Reports: Review your credit reports and challenge any errors or outdated information. Incorrect data can negatively impact your credit score.
Establish Diverse Credit Accounts: Having various forms of credit (retail accounts, credit cards, loans) can positively affect your credit score.
Build Relationships with Lenders: Establish a good relationship with a financial institution by starting with small forms of credit and consistently managing them well.

Credit scores are a measure of your business’s financial responsibility and reliability. As such, they have a direct impact on your ability to secure business funding. Many lending products, including small business loans, lines of credit, and business credit cards, often require a minimum business credit score for approval. A weak business credit score can lead to higher interest rates or outright denial of credit, which can stifle growth and operational capacity.

Frequently Asked Questions:

What is a good business credit score for obtaining funding?

A good business credit score ranges from 0 to 100, with scores of 45 and above considered low to medium-risk. For SBA 7(a) loans, businesses need at least 140 on the FICO LiquidCredit score. Higher scores increase loan approval chances and secure more favorable terms.

Can I get business funding with a bad credit score?

Yes, but it’s challenging. Alternative lenders may consider business revenue and financial statements over personal credit. These options often come with higher interest rates and less favorable terms. Startups and businesses with poor credit can explore online lenders and alternative funding sources.

How important is personal credit in securing business funding?

Personal credit is crucial, especially for startups and small businesses. Lenders view it as an indicator of financial responsibility. For businesses without established credit history, personal credit often determines funding approval. A strong personal credit score significantly improves chances of obtaining business loans.

What steps can I take to improve my business credit score?

Update business information with credit bureaus, monitor reports, make timely payments, establish trade lines, and use business credit cards responsibly. Ensure creditors report to business credit bureaus like Dun & Bradstreet and Experian. Maintain good financial habits to gradually improve your score.

Are there alternative funding options available for businesses with low credit scores?

Yes, alternative options include online lending platforms, merchant cash advances, invoice financing, and crowdfunding. These lenders focus on business viability, revenue history, and cash flow rather than credit scores. Community banks and credit unions may also offer more flexible lending criteria.

How long does it take to build a credit history for a new business?

Building business credit can take several years. It involves establishing a track record of consistent, on-time payments to vendors and suppliers. Businesses should obtain a credit card, work with creditors who report to credit bureaus, and ensure timely payments to build a solid credit history.

What are the typical interest rates for business loans based on credit scores?

Interest rates vary widely based on creditworthiness. Excellent credit can secure single-digit rates, while lower credit scores result in higher rates. Rates depend on market conditions, lender policies, loan terms, and the borrower’s financial situation. Specific rates vary by individual lender.

Do all lenders use the same criteria for evaluating business credit scores?

No, lenders use different evaluation methods. While many rely on credit bureaus like Dun & Bradstreet and FICO, they have proprietary models. Factors considered include revenue history, cash flow, and personal credit. Some use the FICO Small Business Scoring Service for loan evaluations.

Can I still get business funding if I have a high credit score but my business is new?

Yes, a high personal credit score can help secure funding for a new business. Lenders often consider the owner’s personal credit history. Be prepared for more scrutiny and potentially less favorable rates. A solid business plan and personal investment can improve funding chances.

Is it possible to separate personal credit from business credit when applying for funding?

It’s difficult to completely separate personal and business credit, especially for new businesses. Most lenders require a personal guarantee. Over time, as a business builds its credit profile, it may become easier to obtain corporate credit with less personal credit involvement.

What are the consequences of a personal guarantee on business funding?

A personal guarantee makes the individual responsible for repaying the loan if the business defaults. This can put personal assets at risk, potentially requiring liquidation of savings or property. It can impact personal credit scores and future borrowing capacity, creating significant financial strain.

How often should I monitor my business credit score?

Review your business credit score at least quarterly. Monitor more frequently when applying for loans or planning significant financial moves. Changes can occur whenever new information is reported to credit bureaus. Use credit monitoring tools to stay updated on your business credit status.

What documentation is essential when applying for business funding?

Essential documentation includes a business plan, financial projections, balance sheets, income statements, tax returns, personal financial statements, proof of collateral, legal business documents, licenses, contracts, cash flow statements, and management resumes. Comprehensive, organized records improve funding chances.

How do government grants or crowdfunding work for businesses with low credit scores?

Government grants and crowdfunding don’t typically require credit checks. Grants are awarded based on project merit, while crowdfunding depends on business idea appeal and marketing efforts. These options provide alternative funding for businesses struggling to secure traditional financing due to low credit scores.

For businesses, credit scores hold significant importance for several reasons:

Access to Financing: A strong business credit score opens up a plethora of financing options. This is critical for businesses seeking loans to start up, expand, buy inventory, or manage cash flow fluctuations. A good credit score can make the process smoother and can secure lower interest rates, which is financially beneficial for the business.
Supplier Terms: Businesses with a strong credit score can negotiate favorable payment terms with suppliers, such as longer payment periods or discounts for early payments. This improves cash flow management and can reduce the cost of goods sold.
Company Image: A robust credit score enhances the reputation of the business. It signals to clients, suppliers, and partners that the company is stable and a reliable party for doing business.
Expansion and Growth: Companies often need to access larger lines of credit or additional financing as they grow. A strong credit score can facilitate this, enabling the business to invest in new opportunities and resources.
Savings: Over time, lower interest rates and better financing terms can result in significant cost savings for the business, improving overall profitability.