If your company has poor credit, it doesn’t mean that your business will be unable to get the funding it needs. Instead, there are several options, from online lenders to crowdfunding, designed specifically to help business owners with low credit scores gain access to the financing they need to operate their businesses and build their credit.
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What Are Business Credit Scores?
Financial institutions don’t like to lose money. In the eyes of a potential lender, every loan is a potential loss. That’s why everything about a loan – its size, its interest rate, how long you’ll have to repay it, and whether or not collateral is required – depends on how risky it is to the lender.
Credit scores are a simple and theoretically empirical way for a potential lender to determine the likelihood that a person or business will be able to pay a loan back in full. The higher your business’s credit score, the more likely your business is to repay debt.
That’s not to say that companies with low credit scores will never make money or that businesses with good credit never default. Instead, your credit score will help determine the number of options you have as a borrower and the number and severity of safeguards the lender will make.
If you’ve got good credit, lenders will be more comfortable offering large amounts of money with low interest rates. That’s because despite the large up-front cost, a borrower with a good credit score is very likely to repay that loan in full. It works out lucratively for both parties.
For a borrower with a bad credit score, the lender will likely provide fewer loan options, small loan amounts, higher interest rates, and shorter repayment terms. All of those factors are ways to ensure that the risky loan pays off better.
So it behooves small business owners to improve their businesses’ credit scores. But how are those scores calculated?
How Are Business Credit Scores Calculated?
There are three main credit bureaus that calculate the credit scores lenders use when they consider loan approval. Those bureaus are Equifax, Experian, and Dun & Bradstreet. Each bureau uses a slightly different calculation, but all three calculate those scores using the same group of factors.
The first thing credit bureaus look at is how you’ve done with credit in the past. They look at your payment history – was it always on time, in full? Did you utilize a large percentage of your available credit? How long have you had credit available to your company? Another factor is the number of recent credit checks that have been run on your company.
It’s best if they find that your company has made monthly payments on existing debts on time and in full. Having an older credit history is also beneficial, as startups are a riskier bet than long-standing companies. And when it comes to hard checks on your credit, keep them to a minimum. Too many credit checks indicate that you’re desperate for cash, and are likely in a poor financial spot.
Your legal history is also considered. In short, any bankruptcies or collection issues can cause problems with your business’s credit report.
Finally, credit bureaus will consider your company as an entity. How big is it? What industry is it in? Some industries, like the restaurant industry, are much riskier propositions for lenders than others.
What is Bad Credit?
Personal credit scores are expressed as a number on a scale from 300-850, with a score of about 600 often necessary for a personal loan. Business credit isn’t that simple. Each of the three credit bureaus mentioned earlier uses its own scale and some have multiple scores with specific names and purposes.
Experian’s business credit score is perhaps the easiest to understand. It’s calculated on a scale from 1-100, with the number correlating with the likelihood that the borrower will be able to repay a loan. Experian also classifies each business into a “Risk Class” from 1-5 to give a brief idea of the company’s likelihood of default.
An Experian credit rating of 66-100 is considered Risk Class 1. A score of 31-66 is Class 2, and 11-30 is Class 3. Finally, the bottom 10% of credit reports are considered Risk Classes 4 and 5, which are most likely to experience financial strain.
Instead of one number, Equifax provides three separate credit scores within their algorithm.
First, there’s the Business Payment Index, which operates on a scale of 0-100. This number is an indicator of how well the company in question has made payments on its existing debt over the past year. As shown on this example Equifax credit report, a payment index below 90 indicates that payments were made up to 30 days past due, with the scale progressing downward as payments get later and later in total.
Next, Equifax has the Business Credit Risk Score, a number between 101 and 992. This number indicates how likely your company is to repay any additional debts. The higher the number, the more creditworthy the company.
Finally, Equifax’s Business Failure Score calculates how likely a company might be to close in the next year. This is displayed as a score between 1,000 and 1,880. The higher the score, the less likely the business is to close.
Dun & Bradstreet
Dun & Bradstreet also calculates a multifaceted score. Much like Equifax’s scores each tell a slightly different part of the story of a company’s credit, D&B’s scores also try to capture different aspects of a business’s financial health.
Their PAYDYEX Credit Score is similar to the Equifax Business Payment Index. It measures how you’ve paid your creditors in the past year and assigns a number on a scale of 1-100 to show how late you’ve been in payments.
Next, their Financial Stress Score is similar to the Business Credit Risk Score, as it measures the likelihood of default over the next year. Finally, their Delinquency Predictor Score works much like the Business Failure Score, attempting to calculate the likelihood of a company going out of business.
Business Loans for Bad Credit
So you’ve checked your business credit report and none of your scores match up with “good” credit as the rating agencies define it. That doesn’t mean your business’s funding dreams are dead in the water. Many businesses experience times where cash flow issues cause credit problems. However, you’ll likely need to find ways to raise capital that reflect your status as a bit of a riskier bet than a company with better credit. Bear in mind that many of these forms of small business financing can come with pricier origination fees and some might even require a personal guarantee, creating personal liability in the case of default, and nearly all will feature high interest rates.
One of the best forms of business financing for companies with poor credit is equipment financing. In equipment financing, the financed money is earmarked specifically for purchasing, upgrading, leasing, or fixing essential equipment. For trucking companies, that might mean fixing or buying vehicles. A hotel might need new laundry equipment, and so on down the line.
The big difference in equipment financing is that the lender holds the new (or upgraded) equipment as collateral, meaning that if the borrower is for any reason unable to repay the loan, the lender can repossess and resell the equipment in question, recouping much of the money and minimizing risk.
Because of the ability to repossess new equipment, eligibility requirements are lower for equipment financing than they may be for other funding options. A poor credit score is less likely to hold you back on equipment financing because the lender is protected from loss by the nature of the loan.
Bad credit borrowers are still able to receive loans. In a term loan, the simple form of loan in which a financial institution lends money and expects repayment with interest, borrowers with low credit scores often simply receive short repayment terms.
Many online lenders, along with traditional lenders and credit unions, offer these short-term loans. The terms are, as their name implies, fairly short: you might be expected to repay these loans in as few as 12 weeks to a year, and up to three years. They often carry higher interest rates than other forms of lending and are often for less money.
While this form of lending is sometimes available to businesses with poor credit, there are often other factors involved in qualifying. Loan providers will likely prefer that you’ve been in business for a certain length of time and are generating a certain level of income before you receive a short-term loan.
It should also be noted that many alternative lenders offer smaller and short-term loans in the online marketplace. They’re often available to businesses with poor credit and while they may come with higher interest rates, they’re very available when other business lenders are unwilling to extend a loan offer.
Business Lines of Credit and Credit Cards
Lines of credit and credit cards work very similarly and are both helpful for businesses with poor credit. While many lines of credit and credit cards have minimum credit score requirements, they can function similarly. The lender offers a certain credit limit and the borrower makes payments and pays interest only on what is spent up to that limit.
Business credit cards tend to have smaller credit limits than business lines of credit, but both can be used to great effect. After all, showing that you can manage credit below the limit is a known way of boosting your credit score.
Invoice factoring isn’t borrowing in any traditional sense. Instead, the business in need of money sells its unpaid invoices to a third party who collects the owed money from customers. In a way, invoice factoring negates the poor credit of the borrower, since it passes responsibility for repayment onto customers.
Invoice factoring is a form of funding that generally requires a large volume of customers with unpaid invoices, so if you’re a small-scale business it may not be feasible.
The United States Small Business Administration finances microloans through non-profit intermediaries throughout the country. These loans may be available for companies with less-than-perfect credit, as the SBA funding and non-profit status of the intermediaries mean that creditworthiness is less of a factor. These loans are up to $50,000 and can be used for nearly everything, from functioning as working capital loans to financing equipment purchases.
SBA loans are funded with taxpayer dollars, so even the smaller scale of the microloan program will have a more complicated and slower-moving loan application process than other types of financing. You may need to show your business plan, your credit history, your annual revenue numbers, and other financial data. If you’re looking to get cash as quickly as possible, going through government channels may not be the best move.
Merchant Cash Advance
Merchant cash advances, or MCAs, aren’t loans. Instead, they work through a company buying a percentage of future debit and credit card transactions. Instead of making monthly payments, the borrower pays every single time a customer swipes a card.
There are some significant upsides to MCAs. For one, they’re lightning-fast and available to nearly anyone. Most don’t have minimum credit scores and are able to get businesses the cash they need as soon as a single business day after application. The fact that they’re paid through a percentage of transactions also means that if business is slow, you pay less.
However, the APR can be very high on MCAs. You don’t pay interest with them. Instead, you pay what’s called a factor rate, which is a number multiplied by the size of the advance which shows the total repayment amount. if you borrow $10,000 at a factor rate of 1.2, you’re going to repay $12,000, whether you repay it within a month or within two years. If you pay that advance off within a month, you’ll have paid $2,000 for funding in just a few weeks.
Small business loans are the lifeblood of many companies, and there is any number of reasons a company with poor credit may find itself in need of an infusion to the bank account, particularly now. With inflation rising, supply chains in disarray, and uncertainty in the markets, many businesses have suffered issues with their credit and that doesn’t even factor in the fact that new businesses often have low credit scores due to nonexistent borrowing histories.
Think and research carefully when it comes time to seek a loan with bad credit. While many of the cheapest and best business loans will be unavailable until your company’s credit gets a boost, choosing the perfect financing option can lead to the sort of growth and expansion that leads to a marked improvement in credit.