For a small business to grow, it is often necessary to borrow money.
In fact, the Small Business Administration reports that the inability to obtain funding is one of the main obstacles that prevent small businesses from expanding their operations. To increase your business’s chances of obtaining much-needed funding, it is important to understand and establish business credit.
What is Business Credit?
Most people know that each individual has a personal credit score that helps lenders decide how likely a person is to repay a loan. Lenders use that score to determine whether to provide a person with financing—auto loans, home mortgages, or lines of credit—as well as the terms for such financing. However, many small business owners do not know that their businesses can establish a separate credit score—and that there are benefits to doing so.
What Are the Benefits?
According to the Small Business Administration, nearly half of small businesses use personal credit cards for business expenses. However, separating your personal credit from your business can protect your personal credit score in the event your business encounters difficulties in repaying a loan. Likewise, if your personal credit score is low, building a good business credit history for your company can be beneficial, opening up more opportunities for financing, as well as for obtaining better interest rates and repayment terms.
How Can It Be Established?
For businesses like sole proprietorships, which are not legally separated from their owners, it is more difficult to establish a separation between business and personal credit. However, it is not impossible to build separate business credit. The following steps can help your business build a separate credit score:
- Obtain an employer identification number (EIN) from the Internal Revenue Service. Some business forms, like sole proprietorships and single-member LLCs, are seldom required to get an EIN for tax purposes but must obtain one for building separate business credit. Multi-member limited liability companies (LLCs), partnerships, and corporations, on the other hand, are already required to obtain an EIN by the IRS. This number acts like a business’s Social Security number and is used by business credit bureaus to identify your business and track its credit history.
- Open a business checking account to pay for the business’s expenses and employees’ wages. This is required for businesses that are legally separate from their owners, such as LLCs or corporations, but can also be helpful for sole proprietorships in building business credit.
- Obtain a business credit card using your business’s EIN. It is likely you will also have to provide your personal Social Security number, but the EIN will enable business credit bureaus to track prompt payments to establish a business credit score that is separate from your personal credit score.
- Establish accounts with companies who will sell products to your small business on credit. Make sure that you consistently pay the bills on time. Ask them to report your business’s prompt payments to business credit bureaus and to provide positive credit references.
- Contact business credit bureaus to register your small business. The credit bureaus can then open a business credit file for your company.
- If you are currently operating a sole proprietorship, consider forming an LLC or corporation, which are legal entities that are separate from their owners. This will enable you to establish a clear delineation between your personal and business credit.
It is generally advisable to separate your business and personal affairs.