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A small business owner’s creditworthiness can influence insurance costs, investment opportunities, partnerships, federal small business grants, lending decisions, vendor relationships, and more. In the process of making credit-based decisions, the personal credit score of the entrepreneur and business credit history are considered. This can make the process of applying for a startup business loan a daunting task for owners with less-than-perfect credit.
Fortunately for new business owners with bad credit, there are still many financing options to explore. In this article, we will explain the best loan options for borrowers with bad credit and provide some best practices for building good business credit.
How is creditworthiness determined?
While a business or personal credit report can give reviewers a quick look at an applicant’s credit score, there is more to creditworthiness than a number. The following four Cs of credit are collectively used to thoroughly determine a borrower’s creditworthiness.
- Character – determined mostly by the size, geographic location, and age of the business, but may also review the organizational structure and the number of employees, any legal actions concerning the business, like liens or judgments, as well as social media presence and news attention.
- Capacity – reviews the business’s cash flow patterns, monthly revenues, and debt schedules, identifying whether loans are secured or unsecured, if there are any unused lines of credit, and predict the ability of the entity to cover its operating expenses and pay off related financial obligations.
- Capital – uses net worth and annual revenues found on the business’s balance sheet, income statements, and tax returns, to determine whether they have adequate financial resources for new debt.
- Conditions – external factors affecting the business, like market fluctuations, industry growth patterns, political influences, and currency rates.
Business credit score
A business’s credit score is considered when determining overall creditworthiness and is reported by the three major business credit bureaus: Dun & Bradstreet, Experian Business, and Equifax Small Business. A copy of your business credit history can be purchased at any of those agency websites.
There are four major types of business credit scores:
- Dun & Bradstreet’s PAYDEX score – Ranges from 0 to 100 and is determined by the business’s trade references. Scores above 80 are considered good credit by most lenders.
- Experian’s Intelliscore – Uses over 800 variables to generate a score between 0 and 100 with higher scores indicating less risk for the lender or creditor. Scores at or below 39 are considered poor credit by most users.
- Equifax Credit Risk Score– Ranges from 101 to 992 and tells users how likely the business is to become delinquent on payments. Equifax calculates this score based on available credit ratios, business size, and the age of the business bank account.
- FICO’s Small Business Scoring Service (SBSS) – Ranges from 0 to 300, with a higher score indicating less risk for the lender. Used by traditional banks and credit unions, online lenders, and the S Small Business Administration when approving SBA loan applications. Typically, scores under 140 are considered bad credit scores.
Personal credit score
Personal credit scores are often used in conjunction with or in place of the business’s credit score, especially for startup companies. A personal credit report contains similar information as a business report, including the individual’s payment history on personal loans, auto loans, mortgages, and more. Credit scores, or FICO scores, range from 300 to 850. The range that is considered bad personal credit, depends on the lender, but generally, the scores can be categorized as follows:
- 750-850 – Excellent credit
- 700-749 – Good credit
- 620-699 – Fair to low credit
- Below 619 – Poor credit score
Small business loans for borrowers with bad credit
Startup businesses can be challenging because they have not had time to build good business credit, which may put them in the same borrowing position as small business owners with bad credit. However, there are several business lenders, like Biz2Credit, that offer bad credit business loans.
Secured term loan
A term loan is a traditional type of financing where borrowers receive a lump sum payment upfront and repay the debt over time with monthly payments. Secured-term loans use the borrower’s collateral to minimize the lender’s risk, which is an option for startup entrepreneurs and borrowers with lower credit scores. Collateral may be a personal or business asset, like commercial real estate, investment accounts, homes, and equipment. Securing a term loan with collateral may also result in lower interest rates, better terms, and a higher approved loan amount.
Merchant Cash Advance
A Merchant Cash Advance (MCA) is a fast-funding option for new business owners or entrepreneurs with bad credit. When approved for an MCA, borrowers receive a lump sum payment upfront and repay the loan plus financing fees using future credit card or debit card sales. The financing costs of an MCA are higher than other types of financing, but typically approve borrowers with a minimum credit score of 525. MCAs are one of the fastest funding loan products, with some borrowers seeing funds in as little as one to three business days.
Invoice Financing and Invoice Factoring
Invoice financing and invoice factoring are types of working capital loans that use accounts receivable as collateral. With invoice factoring, the small business owner sells their unpaid invoices to a factoring company at a fraction of the invoice’s value. The factoring agent is then responsible for collecting on the invoices and paying the business any excess funds, less the factor rate and agent’s portion. Invoice financing, on the other hand, requires the small business to collect on the unpaid invoices, but still uses the balances as collateral. Invoice financing and invoice factoring are more expensive than other loan options but do not typically require a credit check.
Equipment loans, or equipment financing, are used to purchase equipment or machinery, including computers, computer software, vehicles, construction equipment, commercial kitchen appliances, office copiers, and other fixed assets. The purchased equipment acts as collateral to secure the loan, so equipment financing is a great option for borrowers with bad credit or new owners with no credit. The eligibility requirements for an equipment loan consider the value of the asset, the useful life of the asset, and the creditworthiness of the borrower.
Asset-based business line of credit
A secured line of credit is a type of business financing that works similarly to a credit card. Once approved, the borrower can access funds within their preapproved credit limit at any time with no second application. When working with an asset-based line of credit, a business or personal asset is pledged as collateral to secure the credit line and minimize risk for the lender. Typically, asset-based lenders can extend a secured line of credit worth 70 to 90 percent of the asset’s value.
Alternative financing options for startup entrepreneurs
Small business loans are a great way for startup entrepreneurs to secure the capital they need to build their companies, but they are not the only option. There are several ways entrepreneurs can find funding that doesn’t require qualifying for traditional repayment terms or sifting through loan offers. The following funding options may suit new business owners or entrepreneurs that are working to repair their credit.
Business credit cards
Business credit cards are a type of revolving credit where approved borrowers are issued a maximum credit limit. Cardholders can then use the card to make purchases or withdraw cash up to the credit limit. A monthly statement is issued, either by mail or electronically, which shows the card balance, finance charges, and amount of the minimum monthly payment due. The payments are applied first to any interest charges and financing costs and then to reduce the balance of the account. There are several business credit card companies that work with bad credit borrowers and startup entrepreneurs.
Crowdfunding for business needs is a financing option that has been gaining in popularity throughout the last decade due to crowdfunding platforms like GoFundMe and Kickstarter. Crowdfunding is the process of collecting several small investments or donations from multiple people. There are different methods of crowdfunding that determine if the funds collected are considered donations or if a reward or portion of the company’s equity is exchanged for the investment.
If you are purchasing a franchised business, there may be franchisor financing programs you can participate in. Many companies, like UPS and Gold’s Gym, provide financial assistance programs to their franchisees. The programs are funded by the franchisor or partnering financial institutions and are intended to provide affordable financing to new owners.
Tips to build and improve your business’s credit score
Whether you are just starting out or are an established small business owner, building and maintaining good credit requires knowledge and diligence. We’ve compiled this short list of steps you can take to better manage your business credit.
Note your starting point
The first step in improving your business credit history is to know where you stand. Check both your personal and business credit scores and request a copy of your most recent credit report. Consumers are entitled to one free credit report every year. The credit report is useful because it gives detailed information about your credit inquiries, payment history, and delinquencies. Review the report carefully and if there is any incorrect information, file a dispute with the credit reporting agency and the reporting company immediately.
Use credit-building tools
For startup entrepreneurs or business owners wishing to improve their credit, one of the best ways to improve your business credit score is to consider using financing options to build credit. Making regular, on-time payments on business funding arrangements will be reported to the credit bureaus and positively impact your score. Consider the following small business financing tools.
- Secured credit card – Secured credit cards work like a credit card from traditional lenders, except they require a security deposit which acts as collateral or a personal guarantee for the debt. The minimum credit score requirements for secured cards are much lower than unsecured cards or other types of business loans.
- Credit builder loans – Some credit unions and alternative lenders offer short-term loans for the purpose of building credit history. The borrower deposits funds, typically less than $1,000, into a locked savings account and then makes monthly payments to the financial institution. At the end of the agreement, the borrower can access their original deposit amount plus the monthly payments, less any financing costs and prepayment penalties.
Communicate your concerns
The underwriting processes for business funding arrangements vary depending on the lender, the amount of the loan, and the creditworthiness of the borrower. However, we recommend voicing your credit concerns to the lender before beginning the business loan application process. Consider sharing your business plan and future goals so they can offer the best loan product for your business needs.
Starting a business is a rewarding experience, but applying for business financing can be stressful when your credit is low. If you have less than perfect credit and are searching for the right startup business loan, consider reaching out to Biz2Credit today to ask about a term loan, line of credit, or other financing option. You may be surprised to learn which loan products you are eligible for, like this New York entrepreneur who was approved for a $400,000 secured line of credit in just two weeks.