One of the realities of small business that trips up even experienced entrepreneurs is how the bank reacts when asked to provide a small business loan.
I’ve lost count of the number of times I’ve sat across from an exasperated client as he spills out his story. The business owner went to the local bank, most likely starting at the one that handles his business checking account. I know the next sentence before they even say it. Upon asking for a small business loan, the bank asked for collateral, and barring that, a personal guarantee for the loan.
Well, of course, our hero thinks this is ridiculous. His business is doing great. It is profitable, and healthy, and growing. So, he goes to another bank, only to get the same response. By now, he’s really agitated. Chances are the business doesn’t have anything that can be used as collateral. If there were large pieces equipment, those were likely collateralized by the financing used to purchase them (or even leased). But, he definitely doesn’t want to personally guarantee the loan. After all, isn’t that the whole reason he setup the business structure in the first place, so he didn’t have to put his personal assets at risk?
Ding, ding, ding. (You can’t see it, but I’m also pointing to my nose while I say “ding”.)
Yes it is exactly why he setup the business structure, and it is exactly why the bank won’t loan his business anything no matter how successful it is.
Business as a Legal Entity
I’m not a lawyer, and I don’t play one on T.V. but I know that sometime during Day One of Business Law 101, a budding law student learns that a corporation is legally considered a “person” in many contexts. Legally speaking, a person is different than people. People is a term generally limited to human beings, excepting certain human looking androids that are friendly and searching for their own humanity, but excluding certain human looking androids searching for Sarah Connor. A person, on the other hand, can be not only people, but also other Legal entities including a business or corporation. Once you grasp this concept, it isn’t very hard to see the bank’s side.
If you started your business two years ago, then your business is a two year-old baby. Unless you have gotten credit in the business’ name, it has never had credit before. As a person, your business has a ZERO credit score. Try walking into any bank in the country with no credit history and asking for anything but the tiniest unsecured loan and prepare to be laughed at. So, what does someone with no credit and no collateral do in order to get a loan? They get a co-signer. Guess who the co-signer is for the business with no credit history? Welcome to Square One.
Your Business Grows Up
I counsel all of my clients to go down and get a credit card in their child’s name on the day their child turns 17 (sooner if they can find an institution that will allow it). Many bank’s will issue a credit card in a 17 year-old’s name IF the parent co-signs on the card (and also signs the card agreement on behalf of the minor). The parent goes on the account as an “additional cardholder.” The key is to make sure the credit card account is in the child’s name and that the parent is only a guarantor on the account (otherwise it is likely that recent changes will cause the child’s part to not count, even if listed first on the account.) The parent keeps both cards (the child does not get a card, or the number, or the password to the online access.)
Once the card has been issued the parent makes a modest purchase (something in the $100 range) and then pays the minimum when the first bill arrives. The next month, he pays it off and locks up the cards. Four to six months later he pulls the card back out makes another modest purchase allows a balance to remain on the card for one month and pays it off. Repeat the process a few times, and before you know it, the child will be graduating from high school. The difference between that child and another with less savvy parents? That child has 12 or more months worth of good credit history while the other has none. This small difference will make it much easier to open bank accounts, get other credit cards, get a car loan, and so on. (Right about this point, the parent should have his name removed from the account to prevent any future trouble.)
As a business owner, now is time to help your business grow up too. Most entrepreneurs finance their company’s first years out of their own pocket. There are a multitude of reasons to do so ranging from being the easiest to racking up airline miles. Of course, this improves the business owner’s credit worthiness, but does nothing for the business.
When you start a new (non-sole proprietor) business, you will need to register with the state in some way. These registrations are usually public record. Some states will outright sell the list of newly registered businesses. Even if they don’t sell the list, there are plenty of companies out there with computer programs that simply check the databases against the list of previously existing entries and build their own list of newly established businesses. What this means for you is that you are going to get junk mail. Some of that junk mail will be credit card offers and banks offering to give you a free business checking account. Don’t throw it all away. (Don’t throw any of it away before running it through a shredder). Get at least one credit card and one bank account right away. Make sure they have no monthly fees, no annual fees, no inactivity fees. In other words, make sure they are free. Then, put some money in the bank account (it doesn’t have to be a lot) and charge some office supplies on the credit card. Now, a trick is to make sure you pay a little bit of interest every so often on your card. (Hey! I said a little bit.) Believe it or not, your credit account will look different if you have never paid any interest than if you have. You want credit for paying of an installment account (one that charged interest) so buy a toner cartridge and only pay half of it the first month. You’ll pay just a couple of bucks in interest and then you can pay it off. Trust me, that two bucks will pay you back in spades.
Viola! Your business has credit.
Take That Line Of Credit
Businesses don’t have credit scores the same way people do. What they do have are credit references. That is, other companies that will vouch for your business by saying that they have extended you credit and you have paid them back in a timely manner. If you have a supplier you buy from regularly, ask your sales guy how you can get credit with them. Chances are after paying cash for a couple of months they will extend you enough credit to buy your usual order for a couple of months. Take them up on it by using the credit line and then paying it back. In this case, there is no need to try and get charged interest since this account won’t be scored by a computer somewhere. Instead, they will take a phone call or send a letter at your request to say that you are a good business. Setup more than one supplier this way, just in case.
Get A Loan You Don’t Need
If the first loan you ever apply for is for $75,000, things are going to be tough. This is the reason that many franchise programs have their own financing for their franchisees. If you can stomach the thought of paying some interest to build your business’ credit, you can always get a smaller loan first. Getting a $5,000 loan for some equipment or to pay off a supplier can help build your creditworthiness. However, since you are paying interest on that loan pay it back as fast as possible and don’t go this route lightly. A $5,000 pay back looks nice, but still no one is going to throw 300 grand at you after paying back a small loan.
Do You Need A Car?
If you have a need, and your tax guy gives his blessing, it might be worthwhile to have the business buy or lease a car. Unlike business loans with no collateral, your bank is probably all for loaning you money to buy a car. After all, the car is collateral so even if you disappeared behind your corporate protection, the bank still can legally take the car. Another loan, another history of good credit.
Bite The Bullet
The above tips are nice and they will make getting credit easier for your business, but nothing you do along these lines compares to asking for a $50,000 unsecured loan. Just because you have a couple of business credit cards and a few vendors who give you high marks doesn’t mean your bank is going to fork over 50K without going through your books with a fine tooth comb and discovering that your business makes so much money it doesn’t really need a loan. (Banks love to lend money to those who don’t need it.) So, step up to the plate and put your name on this loan. Make sure you pay it off as efficiently as possible, and next time you need a loan like this, maybe your bank won’t be so insistent on your name being on there too.
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{ 5 comments }
That was quite insightful, thanks.
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