As a business owner, you’ve probably heard of building business credit and how it could make it easier for you to keep your business humming. Getting access to a small business credit helps you keep cash available to cover your operating costs such as day-to-day expenses, purchase inventory, and hiring additional staff.
Therefore, establishing business credit is an essential step for any business owner willing to grow their business. It’s a key ingredient in your company’s financial health as it prevents you from running out of cash and ensures the financing of your business projects.
While there are numerous ways to obtain low credit for your business, establishing a high business credit will help ensure your long-term success. But the most crucial question is how to build business credit? This blog post will help you understand the different steps to build business credit along with a few other key notions you need to know.
Table of Contents
- Establish business as a separate entity
- Get your business registered
- Get an Employee Identification Number (EIN) from the IRS
- Open a business bank account
- Get a business phone number
- Develop credit with reporting vendors/suppliers
- What are the different types of business lines of credit?
- Should I choose secured or unsecured credit?
- Frequently asked questions for building business credit
1. Establish Your Business As A Separate Entity
If you start your business as a sole proprietorship and want to build business credit, you’ll have to change your company’s business model. Sole proprietorships are not able to create a separate business entity.
So, to build business credit, you must choose a business structure such as an LLC, LLP, or corporation. These business structures offer tax advantages and protect you from some of the personal liability you may incur as a sole proprietor. In addition, it is easier to establish business credit and banks, suppliers, or vendors are more likely to extend financing to a separate business entity.
2. Get Your Business Registered
Registering your business gives you more credibility when establishing business credit. The registration with the Secretary of State is done regardless of where the company is located. When you form your LLC or corporation, this is part of the incorporation process.
Check with your Secretary of State office to ensure you’ve met all the criteria for registering your business. A non-registered company will have a hard time building business credit, as creditors want to make sure they are dealing with a company that meets the standards of any legal business.
3. Get a Federal Employer Identification Number (EIN) From The IRS
The Internal Revenue Service is the entity that allows you to obtain an EIN. Your EIN is like the Social Security Number of your company. It identifies your business structure for tax reporting purposes. An EIN is required to change your company’s business structure, open a bank account, sign and obtain commercial contracts, licenses. or permits, and of course, apply for business credit.
However, it is essential to remember that using an EIN for your business is different from how a social security number is used for personal credit. Establishing an EIN is done online and consists of three steps: assessing your eligibility, understanding the process on the online application, and submitting your application.
However, do not confuse an Employer Identification Number and a DUNS Number. Unlike the EIN which is used for tax identification purposes, a Dun Bradstreet number, commonly just referred to as DUNS or D-U-N-S, is intended for business credit reporting.
4. Open a Business Bank Account
A business bank account is the company’s bank account, different from your personal bank account. Having a business bank account makes you more credible to lenders or suppliers when building business credit. It shows the legitimacy of your company and, in particular, the financial management of the company. The business bank account serves as a bank reference on credit applications.
Among other things, it also provides key data that lenders use when considering financing. However, there is a difference between your business bank account and a merchant acquirer, which you will also need to process your transaction within your store. The business bank account thus avoids accounting problems and difficulties at the time of taxation, making it easier to establish business credit.
Learn more about What Is Merchant Acquirer here.
5. Get a business phone number
Just like your business bank account, your business phone number is an essential element that again demonstrates legitimacy to lenders, service providers, and your customers. The business phone number should be different from your personal number.
However, you don’t have to subscribe to an expensive phone service if your business doesn’t need it. In addition, it is also necessary that you list the business phone number in your local directory.
6. Develop Credit with Reporting Vendors/Suppliers
Business credit bureaus are alerted whenever you make purchases of inventory, supplies, or other products on credit. That’s why one of the best ways to build business credit is to ask vendors and suppliers for net terms.
Then, when your company reports multiple trade credit lines, you can establish a business credit score. A good business credit score is proof that you pay on time and can be trusted.
Choose vendors and suppliers who are in contact with a business credit reporting agency. The relationships you build serve as a business reference for your company because they can be used for future credit applications.
Make sure you have a good payment history or personal credit report by paying your debts on time and every time. This builds creditors’ confidence and makes you more likely to receive loans when you want them.
What Are The Different Types of Business Lines Of Credit?
As a business owner, there comes a time when you need to contract a loan, either to improve your product or service or to upgrade other aspects of your business. Or maybe you want capital to stock up before a seasonal rush. Whatever the reason, there are four business credit lines available to you to solve your credit needs.
1. Traditional secured business line of credit
It consists of pledging assets, such as business assets or real estate. This collateral means the lending entity has the right to seize the property you pledged to pay back what you owe. A secured line of credit usually offers better terms because it has fewer risks and is less complicated than a conventional line of credit. You can also benefit from a higher credit line.
2. Traditional unsecured business line of credit
Unlike the traditional secured business line of credit, unsecured lines of credit do not require you to pledge any assets or property as collateral. This means you won’t have to tie up your assets. However, if you choose unsecured lines of credit, you will pay higher interest rates and maintenance fees. You can pay the fees monthly or annually.
3. Real estate line of credit
A real estate investor line of credit is a financing arrangement that allows investors, or vendors, to draw down on a real estate property. In the event of insolvency, a real estate investor line of credit is a relatively simple way to access cash. A real estate investor line of credit allows you to obtain a lower interest rate than other financing methods, and you pay no prepayment or early exit fees. However, this financing method requires a high business credit score to qualify.
4. Business credit card
The Small Business Administration (SBA) also recommends another unsecured financing option: the business credit card. The benefit of this option is that nothing you own, either for the business or personal, is tied up. In addition, you have quick access to the company’s funds, which is a fantastic thing. Unlike the business credit card, other financing options can take several days to transfer funds. It also offers better repayment terms than lines of credit that require fixed monthly payments.
Learn more about How SMBs Can Apply for Loan Forgiveness
Should I Choose Secured or Unsecured Credit?
The decision to take out secured or unsecured credit should be carefully weighed. Before choosing, always consider the pros and cons. For example, the interest rate is more advantageous with secured credit, and the repayment method is more attractive. However, the company must use part of its assets as collateral. The higher the collateral, the higher the loan amount.
If the organization chooses to take out an unsecured loan, the interest rates will be slightly higher. Also, the amount borrowed will be more limited compared to secured business credit. However, it allows the company to access the requested funds more quickly, as the procedure is more flexible with this type of loan.
Loans give businesses a chance to succeed. As such, they are in high demand, but not all companies that apply for them get them. When applying for a business loan, lenders evaluate the business’s track record, the debt amount, and whether the business appears risky. Risky business establishments, such as start-up entities, are often not the winning recipients of traditional loans.
Businesses that take out high-interest loans should plan to repay the loan as quickly as possible so that the interest owed does not become exorbitant. High-percentage loans are best used for short-term financing needs.
What is the fastest way to build business credit?
The best and fastest way to build business credit is to follow these seven steps:
a. Choose the right business structure
This step involves changing the business structure of your current company to one that is more appropriate to help you build business credit. In other words, if you started as a sole proprietorship, you’ll have to change this structure into an LLC, an LPP, or a corporation.
b. Register your business
Once you have changed your business structure, the next step is to register your business. This particular step depends on your structure and the location of your business. Contact the State Secretariat to determine what requirements you need to fulfill and what documents you need to provide to register your business.
c. Obtain a federal tax ID number (EIN)
The EIN stands for Employer Identification Number. It is a nine-digit number that identifies your business and is used for different purposes. You can get it online on the IRS website.
d. Open a business bank account
Financial health is measured by the cash flow in its business bank account. Investors, vendors, or suppliers, in order to grant you loans, will ask you for your bank details, and preferably that of your company. So make sure you don’t use your personal bank account as your business bank account. This could be detrimental to you.
e. Get a business phone number
Just like a business bank account, your business phone number is just as crucial for separating your private and business activities. The business phone number is reserved for investors, customers, suppliers, or any other parties involved in your business.
f. Develop credit with reporting vendors/suppliers
Seek out good relationships with relevant vendors or suppliers in your industry. This will prevent you from paying upfront for items or royalties. Get payment terms such as net-60 or net-90 with only a few vendors or suppliers. Make sure they report these payments to the business credit reporting agencies. This will allow you to begin building a positive business credit history to obtain credit later more easily.
Building Business Credit In a Nutshell
Business credit is a loan agreement between a lender and a company. The lender gives money to the company, and the company pays it back within an agreed-upon period of time with an agreed-upon amount of interest. In doing so, the borrower incurs a debt, which must be repaid with percentages and within a given time frame.
Building business credit is a crucial decision for any entrepreneur. It is the jumping-off point that proves you want to take your business to the next level. However, for creditors to trust you and grant you credit, your business must meet a number of requirements.
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FAQs: How To Build Business Credit
You don’t need good credit before you start your business. Sometimes credit is not necessary. However, if you need to expand your business and need more capital, you will need significant credit, which means having a suitable business model. In the beginning, investors will use your personal credit history to determine the terms and type of credit they offer to the business.
Since LLCs are considered pass-through entities, the financial earnings of your business will be reported on your personal income statement. Your personal credit has an impact on your business, but not as much as a sole proprietorship. However, even as an LLC owner, you can have your own EIN, the tax identification number, which will allow you to access business loans more quickly and establish business credit. Your commercial taxes are reported on with an additional form on your personal taxes, the Schedule C.