Types of Business Credit
Because of the high rate of failure that all start-up businesses face, it is very difficult to be approved for business credit by a financial institution before a business has proven to be successful and has established a positive credit history. What kind of credit a business owner applies for and where he applies is determined by what stage of development the business is in.
VENDOR LINES OF CREDIT: Typically, vendor lines of credit, or trade accounts, are the first source of credit that will be extended to a start-up business. Within most industries, manufacturers or suppliers of the materials that are needed to run a business or produce the business product will often extend trade credit to a business, allowing the business to receive the goods or materials when ordered and pay for them at a later date. During the first few transactions, these vendors may offer very short credit terms, such as Net 15 which specifies that payment is due in full 15 days after the goods are delivered. However, after a few positive transactions, the vendor may allow for extended credit terms, including Net 30 or Net 60 which will allow the business to pay for the goods either within 30 or 60 days from the time of delivery. These types of terms are often coupled with a credit incentive for early payment. For example, “5% 10, Net 30” indicates that a 5% discount will be extended to the business if payment in full is received within 10 days of receiving the goods, and that payment in full (with no discount) is expected within 30 days. For example, if a vendor extends credit terms to a business for $1,000 worth of goods at “5% 10, Net 30,” and the business is able to pay in full within 10 days, a 5% credit ($1,000 x .05 = $50) will be issued by the vendor, and the business will only have to pay $950. However, even if the business requires longer than 10 days to pay for the goods, as long as the invoice is paid in full within 30 days, a positive credit history is established because the terms of the loan were met as agreed.
These types of short-term trade accounts from vendors are often the first few instances of positive credit transactions that start-up businesses can use to establish a positive credit history. However, it is important to keep records of these transactions because many vendors do not automatically report positive credit transactions to the credit reporting agencies. Typically, negative credit is reported whereas positive credit is not. But even if a vendor does not report the credit transactions to the credit reporting agencies, there is still value to the small business. Future loan applications will ask for Credit References from several vendors that the business has had positive interactions with. These references can be an important factor in being approved for future credit. Understanding this, the goal for all new businesses should be to apply for one new vendor line of credit each month, so at the end of six months, a business has a minimum of at least five positive trade accounts.
Take Ismael for example. After years of designing for a major clothing manufacturer, Ismael made the decision to go out on his own and launch his own fashion design business. Initially, the fabric manufacturer where Ismael bought most of his supplies and materials was willing to invoice him and allow him 15 days to pay for his purchases. After six months of regular business and perfect payment history, the vendor increased the terms of the loan to Net 30. Recognizing an opportunity to expand his positive credit history early on, Ismael began making additional purchases at several other manufacturers who were willing to extend the same Net 30 terms to him. These types of small lines of credit were extremely helpful to Ismael as he continued to grow his business. Once the garments were finished and Ismael had sold them to his distributors, he was able to repay the vendors who had extended him credit, saving his limited cash reserves for other immediate expenses.
INFORMAL INVESTORS: Another source of potential credit for start-up businesses is informal investors. Many lenders suggest that start-up business owners first seek financing from informal investors such as relatives or friends. Often, people who the business owner has a personal relationship will be willing to lend money to support the business based more on the history of their personal relationship with the business owner rather than an objective analysis of the business credit history etc. Funding for small business is also often provided by local development corporations, state and local government programs that offer micro loans at low interest rates, private foundations that offer investment opportunities to start-up businesses, credit unions specializing in small business loans, and even colleges or universities with research and development funds targeted at certain industries.
CREDIT CARDS: Business credit cards are often the second phase of business credit that small start-up businesses seek to obtain. There are literally thousands of companies who advertise “Business Credit Opportunities” to meet a wide variety of business needs. However, a vast majority of these companies also require personal credit information on their applications. If a business credit application asks for a Social Security Number (SSN), this usually indicates that a company will be reporting the details of your credit history to the personal credit bureaus and not the business credit reporting agencies. This cross-over between personal and business credit can have a huge impact on your personal credit report and FICO score.
The good news is that there are also several nation-wide corporations who have excellent reputations for extending credit to small businesses without requiring personal credit information. These corporations include Dell, FedEx/Kinkos, Fry’s, Home Depot, Lowes, Uline, Staples, and UPS. Gas credit cards are another source of business credit that typically do not require personal credit information in order to qualify. Companies like Chevron, Conoco Phillips, Exxon Mobil, and Shell report only to business credit reporting agencies and not to the personal credit bureaus.
A secured business credit card is another viable option that business owners should consider when attempting to build business credit. Many local banks offer secured business credit cards that are tied to a business savings account. The borrower deposits a certain amount of money in the account, and then the bank issues a business credit card with a limit that is equal to the funds deposited in the account. For example, if a business owner deposits $1,000 in a business savings account, the bank will issue him a business credit card with a limit of $1,000. The business owner can use this credit card just like a regular, unsecured credit card and will receive a bill from the bank each month. This kind of account is the perfect way to build a positive business credit history until a business owner can qualify for an unsecured credit card.
Ultimately, corporate credit cards are the best kind of business credit that can be obtained and are usually what business owners are looking for. These types of cards are designed by various financial institutions to meet the credit/purchasing needs of corporations. In order to qualify for a corporate credit card, typically a business must provide corporate documentation, a federal EIN, a corporate business checking account, and a DUNS number. Qualified businesses also must have a minimum of two to three years of audited financial statements and an excellent bank reference.