- The Small Business Administration reported a record $5,434,518,200 in 7(a) loans in 2018, up from $4,996,271,600 in 2017.
- Yet big banks approved only 27.8% of the loan applications they received in August.
- One likely reason is that the small business owner had a below-average credit score.
The past two years have been halcyon times for small businesses searching for capital. The lending landscape has never been higher during the post-recession era, and approval rates have increased steadily at big banks, regional and community banks and at institutional lenders for an ongoing basis.
For instance, the SBA reported a record $5,434,518,200 in 7(a) loans in 2018, up from $4,996,271,600 in 2017, and is on a pace to surpass the 2018 figure this year. (The report provides statistics on year to date SBA business loan approval activity comparisons for fiscal years 2012–18 for the period ending Dec. 14, 2018.
Despite the robust lending atmosphere, however, not every company seeking capital is able to secure it. Big banks, the most conservative of lenders, approved only 27.8% of the loan applications they received in August, according to the most recent Biz2Credit Small Business Lending Index, which has tracked approval rates since 2011. While this is a record high figure, it still means that more than two-thirds of potential borrowers are turned away.
Loan approval rates at small banks, buoyed by their activity in processing SBA loans that come with government backing, which minimizes risk, typically hover around 50%. Naturally, this means that half of the businesses seeking small business financing are rejected.
Thus, despite lenders' seeming willingness to grant loan requests, many small business owners are declined, especially those with less-than-stellar credit histories. After all, the economy has been as strong as it has ever been in recent memory. If a firm cannot show enough financial strength to obtain a small business loan, one of the reasons is likely that the owner has a below-average credit score.
Commonly used FICO scores are used by lenders, and they range from around 300 to 850. A good score generally is 700 or above and will allow you to qualify for credit at favorable terms. Any score over 760 is considered excellent, while anything below 650 is considered problematic.
More than 7500 lenders nationwide also rely on the Small Business Scoring Service, or FICO SBSS score, to make lending decisions, although they are not required to disclose they are using it. The Small Business Administration now uses the score to prescreen its popular 7(a) loans, according to Nav.com. Like personal credit scores, FICO SBSS rates small businesses by their likelihood of making payments on time. The FICO score ranges from 0–300. The higher the score, the better, but lenders typically prefer a minimum score between 140 and 180.
Lenders get to decide what information to review and how much weight to put on different aspects. The score is calculated using both personal and business credit, and other business financial information, such as the number of employees, how many years in business and yearly revenue.
There can be valid reasons why a company might have a poor credit history. Entrepreneurs oftentimes underestimate the amount of capital they need when they apply for funding. Start-ups have no track history of payment, of course, and a young entrepreneur may not have a long track record of repaying debts.
Once a company is up and running, inevitably, unforeseen circumstances will arise that negatively impact cash flow (and the ability to pay back debts). For instance, equipment repairs can be costly. Unusual and severe weather can take its toll on the profits of a company. A strong new competitor can enter the marketplace and steal market share unexpectedly. Illness or the loss of a key employees can take a dramatic toll. These factors and others can reduce cash flow and put a business in a position where it needs to borrow to have working capital. Naturally, it is easier to borrow money when times are good.
So how can a company raise the firm's credit score and improve its creditworthiness? Here are six expert tips that can make all the difference.
1. Review your business credit reports frequently. A company's credit score is derived from complex mathematical calculations created to predict the likelihood of a borrower's default. Credit ratings agencies, such as Equifax and D&B, typically examine the following factors:
- Company size and structure
- Industry risk
- Accounts-payable balances
- Timeliness of payments
- Credit utilization (the percentage of the company's available credit currently in use)
- Time in business
- Bankruptcies, liens and judgments against a firm
The main reason to request your credit report is to check for errors. Perhaps the credit agency has not removed the black mark of a bankruptcy that happened during the recession a decade ago. Maybe there was a stretch when payments were late during lean times and the report does not reflect a more recent steady flow of timely payments.
If something is not right with the credit report, do not ignore it; contact the credit rating agency immediately to more quickly reflect accurate information. At a minimum, take advantage of the federal law that lets you get a free report from the three major credit bureaus at least once a year, according to financial advice website NerdWallet. The website for free credit reports is annualcreditreport.com.
"The first thing people should know is what version of their credit score a lender is using. Usually, there are three mortgage versions, car versions, and three credit card versions. Maybe a late payment is recorded on just one of the three credit bureaus," said Diana Nichols, president of Gold Key Consulting, a credit consulting company in Fairfield, Connecticut, that monitors and helps clients improve their credit scores.
"Ask the underwriter what credit bureau they pull and what version. It will vary. If you go on myFICO.com, they give you all of the different versions — auto, mortgage and credit card," added Nichols, whose clients include many high-net-worth individuals. "Once you know what version they use, you can work toward rebuilding your credit on that version."
Credit score calculations are complex, but everyone — especially business owners — should know how they work, not only for business but also for personal ratings, said Nichols.
2. Always pay bills on time, even if you can't pay in full. Late or missed payments are detrimental to maintaining a good credit score. Be sure to pay bills on time. Most credit card companies allow for online payments. You can set up automatic payments with the credit card companies by providing a bank account number. Or you can set up the payments through your bank by setting up the credit card vendor on your system.
The challenge is that if you set up online bill pay, you must be sure there is enough money in the account. Otherwise, the bank account will go into overdraft, which brings down credit scores. If you cannot pay off an entire month's debts, pay what you can before the due date.
For those with credit scores of less than 650, it will take months — maybe even years — to raise them, depending on what type of black marks there are against you and how long ago the bumps occurred. Fortunately, recent payment history counts more than older credit problems, and negative issues will eventually fade as time passes. It is important to note, however, if your account goes to a collection agency, the blemish may remain on your credit history for years.
3. Do not co-mingle funds. Even if your personal credit history is bad, you can still build a positive history of repaying business debts, which will help you to establish a track record of creditworthiness. This is why it is important not to co-mingle business and personal bank accounts and credit cards. Once accounts are separated, be sure that company payments are in order.
If your company is still in the start-up stage, a good way to demonstrate creditworthiness is to open a business credit card and monthly payments on time and in full, if possible. Even if you have the cash to pay for some purchases, put them on the card and then pay them off with the cash during the monthly statement period. By doing so, you are establishing consistency of repayment.
Resist the temptation to open numerous credit cards in an effort to increase available credit. In fact, if you open too many credit accounts too soon, the impact will be negative. It is more effective to have one card and to pay it off in full each month. How many cards should a business have? Start with at least one in order to begin building a history. The total number depends on how much you charge each month and what perks you find desirable. Business owners who like to travel will open rewards credit cards for which they charge their business travel and accrue enough points to travel on vacation for free. Others prefer getting cash back while they build their credit. No matter how many you have, make at least the minimum payment and do it by the deadline date.
4. Incorporate your business. Establishing your company as an S-Corp, C-Corp or LLC provides legitimacy. Once you have incorporated your business, set up utility bills (phone, electric, etc.) in the company's name. If you need a small business loan, banks are more likely to make grant funding to a company that has an established address and bills in its name.
5. Prepay bills when possible. Some vendors might offer discounts for prepayment. They are willing to trade a percentage discount in order to guarantee cash in hand and avoid the hassle of chasing a delinquent payer. In such cases, both sides benefit. If you are in a position to pay early at a reduced rate, it is an opportunity to cut costs and thereby improve cash flow. As an added bonus, vendors whom you pay early will likely serve as credit references, if you need them.
6. Run a profitable business. The goal of opening a business is to generate profits, and a key element in doing that is to minimize the firm's costs. Keep close tabs on inventory. Manage staff schedules wisely, particularly when business is slow. Utilize technology to streamline operations and cut costs.
Additionally, look into getting competitive bids for goods and services that are currently being provided to your company. Take the time to negotiate the best financial terms that you can, if you strike a deal to cut costs 5% with a vendor that you pay $10,000 each month, it winds up being a significant savings. Auditioning new vendors also helps keep your current vendors on their toes. If they know that they have to compete for your business, they are less likely to get complacent.
After all, credit scores are only one measure lenders use when assessing a business' creditworthiness. Bankers want to see revenue growth and profitability, company collateral and its cost structures.