Here is the problem. Most everyone who is thinking of starting their first small business does not have an excellent credit score. Your plan to start a business as a young adult, while working part time, or nearing retirement means that you probably have no credit (especially true for younger entrepreneurs) or your cash reserves and equity are less than great. If you’ve been laid off or gone through a divorce, my heart goes out to you and your credit score. But that doesn’t mean that you can’t start a business to improve your situation. A solid business could be the best way out, so let’s talk about your options.
The three basic options are
- Credit lines from a bank
- Outright bank loans or personal loans from family and friends
- Credit cards
Lines of Credit: If your credit score is below 700, you will not be able to expect a line of credit from the bank without offering everything you own as collateral. I tell all my clients that you need to establish lines of credit when you don’t need them. Proof of a stable business and steady income is the key to securing these lines of credit. If you really need credit from a bank, it’s probably too late.
If you are in a good place financially, then I would recommend you go to a smaller bank or local credit union. Their terms can be more agreeable, and you can develop a personal relationship with the person who will make the decision. The old advice of pre-recession credit was based on the 4 C’s: credit history, cash flows, collateral and character. Now it’s more about credit history than anything else. Chase, Wells Fargo and Bank of America have bigger fish to finance so save yourself the time if you are at risk of slow growth.
My last word on lines of credit is that the guarantor of the loan can call in the debt every year. If your bank wants to see your financial statements each quarter (and they will) and see that you are running up debt, they will insist you pay off the balance and interest by the end of the year. It is a terrifying prospect, but I have been there. Without a solid reserve or generous friend, you will end up robbing Peter to pay Paul.
A loan is normally not something you would get until you need it because it’s normally for one specific purpose. A line of credit is something you obtain before you need it. Remember the line of credit, unlike a loan, is not for one specific purpose.
In addition, loans have monthly payments over a long period of time (2-6 years or so). They are one time deals for long term debt. The downside is that they cost more in the end, so be very careful to choose this option. And most importantly: read the fine print and shop around.
Credit Cards: Not a great option, but many start-ups use credit cards to fund the day-to-day. So here is my best advice: It never hurts to have a few credit cards hidden in your desk drawer for emergencies. Be very careful using business credit cards, as you can easily abuse them. I’ve had an experience where a monthly credit card statement came, and no one in the business could adequately explain what the charges were for.
The upside is that responsible credit card use builds up your credit. The down side is that credit card companies don’t negotiate and the interest rates can kill your business on the spot. So, if you can’t trust yourself or your employees stick to debit cards and don’t spend money you don’t have.
In conclusion, if you can get it, a line of credit is the lifeblood of a successful business. Get credit before you need it. When you get one line of credit, get more credit. Loans and cards have their drawbacks as Asheesh Advani, CEO of Covestor, writes on Entrepreneur.com
For example, it’s possible to request that certain personal assets be excluded from the guarantee or that the guaranteed percentage of the loan declines as the business matures or surpasses a certain net-worth threshold. Private loans from relatives and other business associates are also subject to negotiation. However, for credit-card issuers, the offer for business credit is usually a take-it-or-leave-it proposition–and you must accept the personal guarantee if you want the card.
Always do your research when taking on debt. Be very clear on the terms and try to negotiate better ones if you can. I can’t stress enough that planning ahead will save you thousands of dollars and your credit score.