Establishing good credit is a key step for a small business, and not just because it paves the way to getting loans at good rates.
High credit scores can also lead to better payment terms from vendors. And it can mean more sales, because business customers sometimes check the credit rating of a new firm before trusting it with their orders.
“Your cost of doing business will go down and your cost of growing will go down,” said John Schafer, a partner in the Newport Beach law firm of Manderson, Schafer & McKinlay.
Good credit allowed Cyndi Finkle to jump on an unexpected chance to buy and expand a Culver City art studio with a business loan from a bank.
“I started my business credit relationship with the bank years ago, and when I had this opportunity to buy this new business last year, I already had a relationship and a history and a good track record,” said Finkle, who built her credit during 10 years of operating a television industry catering business. Business credit ratings are separate from the personal credit reports of a business owner, although some credit grantors want to see both.
Just as with personal credit, a business gets good ratings by making its payments on time. Business credit ratings range from zero to 100, the higher the better. Experian Information Solutions Inc. and Dun & Bradstreet Inc. are two well-known business credit rating companies.
It’s smart for a small business to start building a credit history before it needs one. Finkle, for example, said she opened a line of credit for her catering business in 2008, its best year ever.
“I was flush with cash, booked on lots of shows, and the future looked very promising,” she said. “That is when I went to the bank and opened up a $40,000 line of credit and a $10,000 overdraft account.”
She didn’t need them then, but they later helped her survive the recession. She paid off the amount on time, and that put her credit in good shape when she needed a bank loan to buy her new business.
Getting started on building credit can be straightforward.
“The first thing to do is to get a small-business credit card,” said William Davey, a business consultant specializing in access to capital at the nonprofit Small Business Development Center in Santa Ana.
Opening a business bank account and filing public documents for a business license or incorporation will help establish a new firm as an entity that lenders can examine for creditworthiness, said Adam Fingersh, senior vice president of marketing for Experian’s Business Information Services in Costa Mesa.
Even with good, established business credit, however, a small-business owner can sometimes be called upon to personally guarantee a major debt.
Finkle had to personally guarantee her loan to buy her business, and Schafer and his law partners had to sign personal guarantees to get a lease on office space for their new firm.
Schafer advised small-business owners to read the fine print in loan guarantee documents and be ready to negotiate terms.
A small-business owner should try to get an opt-out clause that erases the personal guarantee when he or she leaves the company or sells it, Schafer said. Also, it would be good to get a so-called burn-off clause to lower the personal guarantee as the debt is paid off.
Too often, small-business owners don’t bother with these matters, Schafer said, and that can lead to disaster. “When things go bad, people have to go back and look at their documents and say, ‘Oops, we messed up.’
“I cannot tell you how many times I have seen bad legal documentation,” he said.