You’ve gone out on your own, you’ve got a great business going, and you’ve got the energy, ambition, and smarts to stick to it. The problem, as always, is money. How can you both secure funding for your idea and build a business credit score that will see you through each phase of your plan as your business matures?
As a sole proprietor, your chances of receiving a traditional loan from a financial institution are not high. As recently as January 2015, less than a quarter of small businesses applying for bank loans were approved, and sole proprietors are viewed as particularly risky.
Why are lenders so wary of sole proprietors?
Legally speaking, you’re the only one accountable for the success or failure of your enterprise. While you may be smart, talented and hardworking, a single instance of bad luck—an accident or an illness, say—could remove you from the picture, loan unpaid, with nobody to fill your shoes. Combine this with the unpredictability of success inherent in all fledgling small businesses, and you get a formula guaranteed to give something as conservative as a bank a queasy stomach.
What would a lender need from me in order to feel more secure?
One concern lenders will always have is credit history. And this is where you may find yourself in a particularly frustrating bind. Even if your personal credit history is flawless, a bank or credit union might not take you seriously unless you can show a strong business credit history as well. Yet this is what you’re in the process of building—a key step of which is borrowing and repaying the very thing you’re being denied.
Let’s look at a few different options for building business credit as the sole proprietor of a small business.
It’s common for sole proprietors of small businesses to pay for all their needs at the beginning with personal credit cards. By taking this route, however, you’re personally liable for those debts if your business fails. More important to the discussion at hand is the fact that this approach, along with putting your personal credit score in jeopardy, also prevents you from building business credit scores that will become crucial if your business succeeds.
One way to protect yourself and build business credit at the same time is to incorporate your business. By forming a corporate entity such as an S or C Corporation or a Limited Liability Company (LLC), you erect a safeguard between your personal life and the life of your business, and set yourself up to establish an independent business credit history by creating a distinct corporate identity. You’ll apply for a Federal Tax Identification number from the IRS—more or less a social security number for your business—and this will allow you to register with business credit bureaus and submit corporate credit applications to suppliers.
While using personal credits cards to get your business up and running may initially seem like the quickest and simplest option, it’s essential to keep the big picture in mind. As an incorporated business, you’ll have (1) 10 to 100 times more financing outlets than what you could find relying on personal credit and a way to protect your personal credit during the inevitable ups and downs of business cash flow.
Business credit cards
Securing a business credit card is a relatively simple way of building up your business credit score, since you only have to focus on making your payments on time or early while maintaining a low (or no) balance on the card.
You don’t need a federal tax ID to apply for a business credit card; just your social security number. This means that your personal as well as commercial credit score could be affected by what you do with it, depending on how the issuer reports. (This chart shows you whether major card issuers report activity on the owner’s personal credit reports.)
As a sole proprietor, there are factors, such as company size, that may negatively influence your business credit score and you will not be able to control. On the flip side, the factors that you can control can have a huge impact on your business credit. So don’t give up! Borrow what you can from what is available, and pay your bills early or on time.