As you no doubt already know, your credit report is one of the most important things a lender will look at when deciding whether or not to approve you for financing. A good credit history can go a long way toward convincing a loan officer or underwriter that you’re a good risk to pay back what you borrow, while a less-than-stellar credit picture can do the exact opposite.
So does that mean you’re totally out of luck if you’ve had some difficulty in the past and your record is far from spotless? Fortunately, no!
Check Your Credit Report
Knowing what you’re dealing with will help you formulate a plan to improve going forward. Bad credit can be fixed over time, so don’t get discouraged if you’re in a hole right now.
For most small businesses, your personal credit rating will be as important as your company’s. In some cases, as with startups, you won’t even have a corporate rating yet, so your personal history will be all a lender has to go by.
By law, you’re entitled to receive a free copy of your personal credit report from each of the three big credit bureaus, Equifax, Experian, and TransUnion, once a year. To get a free credit report, visit the central website they set up or call toll-free 1-877-322-8228. You’re also entitled to a free copy of the report if you’ve been turned down while applying for a credit card or loan.
You may want to order from one company now then another in a few months as you work to improve your credit score so you can check the progress you’ve made. If you find any errors on your credit report, dispute them. The Federal Trade Commission has a step-by-step guideline for how to do it.
Your Assets Influence Your Ability to Get a Loan
While it’s true that your credit rating is the most important factor traditional lenders will consider when you apply for a loan, it’s not the only one. In some cases, you may have other assets that can help offset their concern about your previous credit history.
If your cash flow history is strong, that’s a positive. Excellent prospects and projections, especially if you have signed contracts for future business, can also aid your ability to get a loan. Can you offer some valuable collateral as a guarantee? A lender will want to know there’s something tangible to fall back on if you default.
Your home is probably the ultimate in collateral, and if you have enough value there, you might consider applying for a home equity line of credit to use for your business. Keep in mind, however, that you risk losing your home if you default on the loan. This can be a very risky option, indeed, especially with an unproven startup, so consider this very carefully before you proceed.
You’ll also need to show your own investment in the business, which is another demonstration of your commitment to success. A strong business plan shows the care and effort you’re putting into the success of this company.
Your Reputation Counts
Your character matters. There are many reasons your credit may be tarnished, and sometimes, your reputation within your business community will help.
Be prepared with information about previous successes you’ve had in business, referrals and recommendations from other respected professionals and community members, and your involvement with charities and other community organizations.
Where to Go When the Bank Says No
If you do find a traditional lender that will make a loan to you with bad credit, expect to pay a significantly higher interest rate, agree to very stringent (likely shorter) repayment terms, and put up more collateral. But what if the bank says no?
You might consider taking on a partner who can buy into the business with enough cash to tide you over, but be aware of the ownership and control you’d have to give up—if you can even find someone to invest.
Some lenders will consider a loan to someone with bad credit if they have a co-signer that has good credit. This gives them more assurance that payments will be made.
Friends and family might also be options if you’re sure these relationships can withstand the potential uncertainty of the investment involved.
Your current suppliers or vendors can be sources of funding, especially if they have a vested interest in your success. Talk to them about extending you credit, and if they will, ask them to report the arrangement to the credit bureaus. This is another good way to help rebuild your credit.
Lending Options for Businesses With Bad Credit
In most cases, traditional lenders such as banks have the lowest threshold for risk, and will put the highest emphasis on credit scores. You’ll usually have to pay more to get a loan with bad credit, but they do exist. Some don’t even require collateral, but rely more on the performance of your business.
Until you can get your credit score into good shape, you’ll most likely have a better chance of success with a microlender who understands that you need money for employee salaries, to buy inventory, and pay the rent to get back on your feet.
If the banks have turned their back on you and you decide to find another way to fund your business, there are some options. Explore them in depth before you commit, but here’s a quick overview.
These are usually non-profit organizations that specialize in making smaller loans to small businesses. Funding will generally range from $5,000 to $50,000, and many will put much less emphasis on your credit history. Another plus of a microloan is that it will be reported to the major credit bureaus, so you’ll actually be building better credit as you pay it back.
You can expect a microlender to charge an APR in the range of 8 - 22%. While you might pay at the higher end if you have bad credit, the APR you’ll pay via a microlender is likely to be better than the APR you would pay if you opt for a cash advance or an alternative lender, detailed below.
You can apply for a microloan online via us.accion.org. The Association for Enterprise Opportunity can help direct you to reputable microlenders in your area. Many also offer financial education, webinars, and seminars that can help you learn to run a successful, profitable business.
This is an entire category of loans that doesn’t rely on your credit rating at all. It can be as simple as getting cash by using your credit card, to as complex as selling your invoices or accounts receivables at a discount, and getting money for them immediately instead of waiting to collect.
With a credit card cash advance, you’ll usually be able to get an amount close to the credit limit you have on the card. You’ll also be charged an extra fee, usually from 3 to 5 percent of the amount you borrow, with a minimum of $10. Interest rates on cash advances are high, with the average annual percentage rate at 24%, and some as high as 36%. The interest will start on the day you take the cash out, with no grace period like there might be on purchases.
If you do a significant amount of business through credit and debit card transactions, you can probably get a merchant cash advance. This is technically not a loan, but a sale of your future income. For example, a cash advance company would give you $20,000 in exchange for $25,000 of upcoming sales. They hook right into your payment processor and take a percentage from each day’s proceeds until the money is paid off. Again, your credit history doesn’t matter here, but you pay for the privilege. Depending on how quickly you pay the loan back, your APR can be as high as 30 - 200%. Because merchant cash advances aren’t loans, they won’t help you rebuild credit.
If you rely more on traditional invoicing than credit card sales, factoring is a different type of cash advance to consider. With factoring, you sell your current invoices or accounts receivables at a discount, getting a cash advance on the amount owed to you minus a percentage the factoring company keeps as a fee. The rate will depend on the industry you’re in and how much you’re selling, but generally range from 2 to 5% per month. At 2% a month, you’d pay an annual percentage rate of 24%, while at 5%, the figure rises to 60%.
Because alternative lenders generally use different criteria than banks, they may also be options for businesses with bad credit. These firms have algorithms that include things like a company’s web reviews, Facebook and Twitter interactions, along with online sales and cash flow when deciding whether or not to approve financing. Funds from these alternative lenders range from true business loans to cash advances, lines of credit, and personal loans.
It’s particularly important when dealing with these firms to do your homework and understand exactly what you’re agreeing to. Because you will have to pay fees in addition to interest that aren’t always advertised alongside the rate, the APR can easily top 50%. There may also be prepayment penalties, and in some cases, you’ll have to make daily payments.
Also keep in mind that many alternative lenders fall outside bank regulations, so the protections you’re used to may not apply. You can figure out the APR for various types of loans with this easy-to-use calculator.
If you decide you don’t want to borrow money but you still need funds, then consider crowdfunding. With crowdfunding, you raise money from people who contribute cash in exchange for some type of reward or share of the company for having invested.
There are various crowdfunding platforms online, usually specializing in different industries such as the arts, technology etc., and they charge from 4 - 10% of the money you raise. Remember to also factor in the cost of the rewards you need to offer.
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