Are you a new small business owner who needs money to get your startup off the ground? If you’ve been trying to avoid taking out a business loan, you may be approaching it all wrong. At least, that’s the conclusion of a study published in the Journal of Corporate Finance.
The study looked at the results of taking on debt during the first year of a company’s operation. Contrary to what you might think, businesses that took on debt were more likely to succeed and achieve higher sales—especially if they used business debt to launch as opposed to taking on personal debt.
This isn’t to say that taking on debt is a recipe for success. However, startups that are able to obtain business loans have passed an important test: convincing a banker that their business has good prospects for success. Once a banker has invested in your business, they’re more likely to monitor your business’s progress and offer advice that can help you make smarter decisions and help your business grow.
Bear in mind that taking on personal debt can have the opposite effect. The study found that business owners who used their personal credit to finance their businesses did worse than those who obtained business loans. Frequently, these entrepreneurs end up tapping out their own credit at the start of their businesses, and then can’t obtain credit from the bank.
Build your business credit rating
But how can you get a business loan when you’re just starting your new business and don’t have a track record yet? Sometimes, you have to put your personal credit on the line. The key is to make the switch from using personal credit to business credit as quickly as possible. To do this, you’ll need to build up your business’s credit rating so you can improve your chances of getting a business loan or line of credit.
Here are some steps to take to build your business credit rating from scratch:
1. Get a business credit card and use it to make startup purchases such as equipment, supplies, and inventory. The study notes that you can typically get a business credit card based on your personal credit history. Be sure to pay off the balance on time every month; your goal is to enhance your credit rating, not get over your head in debt.
2. If you can’t get approved for a business credit card, apply for a business account with a business supply store or big-box store. Use the same approach as you would with any business credit card: Make purchases from the store regularly and pay them off on time and in full to build your credit rating.
3. Make sure that any vendors or suppliers you work with report your business credit score to the credit scoring agencies. (Not all of them do, so you’ll need to check.) That ensures you will be recognized for making on-time payments, which helps build your credit rating.
4. As your business credit rating improves, you can gradually work your way up from business credit cards to applying for a traditional line of credit from a bank, or applying for a bank loan. Keep up your good habits of making on-time payments, and your business credit rating will rise even further.
5. Monitor your business credit rating regularly. Experian, D&B, and Equifax are the three credit reporting agencies that track business credit scores. Unlike your personal credit report, you’ll have to pay to check your credit report, but it’s worth the expense to make sure your business is in good standing. If you find any errors in your business credit report, take steps to correct them.
As a small business owner, you probably take pride in pulling yourself up by your bootstraps and financing your startup on a shoestring. However, when it comes to building your business’s reputation, you need to show that you can manage debt in order to get financing in the future.