Obtaining financing is still difficult for small business owners, particularly those with poor personal credit histories. For most lenders, the business owner's personal credit score has become an all-important classifier, even though many individuals have compromised scores because of severe illness, divorce, or other life-changing situations. A 2010 Federal Reserve report on small business use of credit cards showed that 20 percent of companies that applied for business credit cards were denied. Jonathan Goldhill, a longtime small business coach and principal at The Growth Coach in Calabasas, Calif., spoke recently to Smart Answers columnist Karen E. Klein about how entrepreneurs can improve their credit scores—and their chances for financing. Edited excerpts of their conversation follow.
Karen E. Klein: FICO scores typically range from 300 to 850, with scores over 700 considered good. What does a credit score really stand for?
Jonathan Goldhill: It is a proxy for how well you manage your finances and how you take on risk. If I were an investor looking at an entrepreneurial business and the entrepreneur had a really bad credit score, I'd be reluctant to invest.
It goes beyond that, too, to partners and employees. Would you hire a bookkeeper who has a poor credit score—or a car repossessed or a default? If you're going to be partnering with someone or hiring someone in a position of fiduciary responsibility, you want them to have a high credit score.
How important is it for entrepreneurs to know their credit scores?
You can request a free copy of your credit report from FICO. So it's easy to look at once in a while and make sure you're protecting yourself from fraud or error. You can also get a subscription service that sends you a consolidated monthly credit score report.
That might be easier for a small business to do, instead of trying to remember to check it once a year. Just be careful that you're not subscribing to something that you don't want and can't cancel out of.
What factors go into figuring a credit score?
They look at the amount of debt you're carrying, relative to your capacity to pay back a loan. They also factor in your credit history and how long you've qualified for credit.
But debt-to-net-worth is the critical ratio that influences your credit score and your creditworthiness in general. A typical bank doesn't want to lend to you when you are carrying more than $2 of debt for every $1 of equity or net worth.
What are the credit reporting agencies looking at when they examine your credit history?
The longer you've been in business, the easier it is for a lender to evaluate your track record. They consider repayment a function of track record: So if you've got too many late-pays or extensions or defaults, it's an indication that you aren't a good money manager and are not a good risk.
What you want to do as a business startup or a young business owner is to develop a positive credit history. Start by borrowing small amounts and demonstrating that you can repay on schedule.
Does that advice apply also to trade credit that a small business might seek from a supplier?
Yes. Your credit score does not reflect input coming from trade creditors like supply houses. But once you've established a good credit history with one supplier, you can take that as a reference to other suppliers who may also extend you credit. Typically you'd list a supplier who has worked with you on a credit basis as a trade reference.
What tips would you give for small business owners looking to raise their credit scores?
Obviously you want to pay your bills in timely fashion and not have any late payments. You don't want to have a lot of outstanding debt, so pay off or pay down high balances, starting with accounts that have the highest interest rates.
A lot of people can't completely pay off their debt. Is it smart to consolidate debt?
It's better to pay it off than to move it around but as you say, most people can't pay it all off. So they consolidate debt or put it on new credit cards to save money. The truth of the matter is, even after you pay transfer fees, you'll probably save money by consolidating debt at a lower interest rate.
Does that negatively affect your credit score, though?
The main component of the credit score is your outstanding debt to total income ratio. If you're moving debt around, that may cost you a few points, but in the long run if you can lower your interest expense and that helps you pay down the debt, it's helpful to do that.
What about agencies that say they will help repair your credit. Are those worth trying?
I would say buyer beware. Don't work with someone unless you get good references on them and know they are legitimate. Most of what these credit repair agencies tell you is stuff you could look up yourself in a book. It's always helpful to have a consultant working with you, but look for a nonprofit organization or someone who is licensed and credible, like a CPA.