According to the Federal Reserve Bank of New York’s 2017 “Report on Startup Firms,” over half of startups less than five years old report difficulty in obtaining credit. Even when credit is available, it’s often not enough, and the Fed report notes that 69 percent of startup applicants obtained less than the amount of funds they initially sought.
Startup applicants who did not receive the full amount of financing they sought cited insufficient credit history as the main reason for the inadequate funding.
Some startups are simply not applying for funding at all, opting for a “back pocket” approach, or going into gig economy or home-based businesses which require less capital. Twenty-seven percent of those who did not apply for loans, did not apply because they believed they would be turned down because they have a poor credit score, or have had financial challenges in the past.
Those credit challenges need not prohibit a budding entrepreneur from launching a business, however. First of all, born-in-the-cloud startups which require less physical infrastructure do not require the high levels of startup cash which were once considered essential. And for those startup entrepreneurs who do choose to seek funding, it is possible to improve their personal credit scores and obtain more of the funding they require.
The Small Business Lending Landscape
Personal credit scores are an important consideration for a startup entrepreneur – even though accountants and advisors will always tell you to keep business and personal separate, in reality, doing so is functionally impossible in the beginning. If the business is organized as a sole proprietorship or partnership, the business owner is virtually indistinguishable from the business itself; and a new corporation will not have the track record and history necessary to obtain a corporate loan. In other words, the company’s ability to obtain financing is almost always directly tied to the individual’s credit profile and ability to secure a loan.
Even with a good credit score, finding a loan is challenging at best for a startup, as conventional lenders tend to be very risk-averse, especially in today’s low interest rate environment. Simply put, banks do not like startups. They like applicants who have assets and a steady income. That said, small business lending has seen some expansion. The Thomson Reuters/PayNet Small Business Lending Index three-month moving average was nearly six percent as of November 2017 compared to November 2016. Much of the increased lending can be attributed to decisions on the part of the Fed to consistently and gradually raise the federal funds rate, allowing banks to charge higher interest. It’s a bit of a Faustian deal – small business credit becomes more available as it becomes less desirable.
Practical Ways to Improve Your Credit and Launch Your New Business
According to Credit Sesame, an excellent score is 750 and above, a good score is 700-749, and a fair score is 650-699. If you fall anywhere in this range, financing will be more readily available, and at more favorable rates. If, however, you fall in the poor (550-649) or bad (550 and below) range, you’ll find it nearly impossible to get a loan.
All is not lost if you have poor or bad credit, though. The good news is that credit scores are malleable and can improve over time as you make smart financial decisions. Keeping this in mind, here are some ways entrepreneurs can boost their credit:
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- Fix Errors on Your Credit Report
It may be hard to believe that something so significant could be riddled with errors, but it’s important that you check your credit report frequently and deal with any issues that may be present.
Credit bureaus are legally obligated to verify any disputed item. When you spot an error, you have the right to request that the credit bureau verify that it is legitimate, and if the bureau cannot do so, then it must be removed.
The Federal Trade Commission and credit bureaus tend to discourage credit repair, largely because of the proliferation of unethical and illegal credit repair schemes. There are however, legitimate tactics that can be employed. “Government agencies and credit bureaus alike toe the line implying that consumers shouldn’t try to fix bad credit, because it simply can’t be done,” explains Lexington Law, which also notes that an individual’s right to fix their credit is legally protected under the Fair Credit Reporting Act and other federal legislation.
- Learn how to read your credit report
Credit reports can be confusing, and because they seem “official,” there is a tendency to believe what is on them. Learning how to read them will almost always yield some benefit to you, and some obvious discrepancies that you can get removed, giving a quick boost to your score. Aging of debt and statute of limitations are two areas to watch for. The “date of last activity” on the report is often inaccurate – compare this date with your own records to verify. If the debt is being pursued by a collector, there is a high likelihood that the date of last activity is reported as the day the collector bought the debt. If that is the case, it is inaccurate, and you can have it removed.
Watching the dates on each item closely may also yield some statute of limitations infractions. In most states, the statute of limitations may be only three or four years. Unethical collectors will attempt to collect debts which are past the statute of limitations, and when they do so, it will go on your credit file by default. This too, can be removed.
- Don’t Forget the Basics
There are a handful of common-sense tactics that every credit advisor recommends, and most people understand without being told. But it’s a little like being told to eat your broccoli. You know it’s good for you, you know you need to do it, but you put it off.
The most basic advice is to catch up on any late payments or overdue bills you have on our account, and the best time to do so is before any entrepreneurial venture is launched. These delinquent accounts hurt your score and could come back later to hurt your ability to run your new business.
Another basic is attending to your credit utilization rate. Some financial advisors say that having multiple credit cards is bad, but this is not the case. Having multiple credit cards which are all maxed out is what is dangerous – when you have multiple cards and you use only a small fraction of available credit, you will get a boost to your FICO score. Roughly 30 percent of your FICO credit score is determined by your credit utilization rate. A credit utilization rate is a simple calculation that’s determined by taking the amount of money you’re borrowing and dividing it by your total credit limit. So, if the total credit limit on all your credit cards is $20,000 and you’re borrowing $5,000, your rate is 25 percent. Lower utilization rates are a major factor in a higher credit score.
Get Your Act Together
If you want to stand any chance of being successful in the business world, you need to start by getting your personal finances under control long before you start planning your launch. Not only will this put you in a position where you can be successful, but it’ll also improve your credit score and enhance your attractiveness to lenders.