Regardless of your particular industry, business credit is one of the most important tools for establishing sustainable profits. Groomed appropriately, business credit may be all that stands between an average investor and those that have experienced significant success. In fact, few things are more important in the arsenal of a real estate investor. Credit is perhaps the most important asset an investor can exercise. While private money is the most readily available means of funding deals, business credit is most often used to supplement it. After all, without credit, how do investors secure funding? Essentially, credit is a tangible resource that provides value to a respective company. Some real estate investors may go as far as calling it an economic tool that can singlehandedly establish the financial foundation of a company.
At the risk of sounding too cliché, credit may as well be referred to as a resume. It is, for all intents and purposes, a record of past transactions – and maybe even transgressions. Building business credit will identify your strengths and weakness as a real estate investor, and ultimately dictate whether or not other people will want to work with you.
Defining Business Credit
In its truest form, business credit is essentially the equivalent of a financial business profile. Accordingly, business credit is a quantifiable manifestation of payment history, debt ratio, and whether or not you qualify to take on new debt. Having said that, you should already be familiar with your own credit profile. Your business credit, on the other hand, may be a foreign concept all together. The following will illustrate the differences between both personal credit and business credit:
Personal Credit & Business Credit
Investing in real estate provides individuals with an opportunity to build, maintain, and acquire both personal credit and business credit. The addition of business credit to an investor’s arsenal will prevent a scenario in which they must rely on personal credit. A business can be grown and built without risking your personal credit score. Accordingly, while both are used in entirely different situations, they rely heavily on one another.
Credit, as you may know, goes farther back than many realize. From the moment you accept your first job or even apply for your first credit card, your credit is being tracked. Subsequently, everything from that moment on, pertaining to credit, is placed in a personal profile. Other wise known as a credit report, this profile speaks to your ability to repay any debts that may be accumulated. It is essentially a compilation of reports by those issuing you the credit. However, instead of releasing this information solely to the borrower, they give it to what is known as a credit bureau. The information given to the credit bureau will accumulate over an entire lifetime and will include: changes of address, career moves and credit applications. For example; if a car dealership inquires about your credit score, it will be reported and added to your portfolio. In establishing whether or not you qualify for a car loan, the credit bureau will be made aware of the inquiry. While this does not reflect poorly on a credit report, multiple inquires will raise a red flag.
It is of the utmost importance to have a well-established personal credit score before pursuing one for your business. However, once business credit starts to accumulate, the need to have a viable personal credit line becomes less and less relevant. Personal credit becomes all but irrelevant for business expenses once business credit has been built up. Ultimately, you will need personal credit to establish a business credit, but once the business credit has been established, you will lean more towards the business credit. Do not become complacent with your personal credit, however, as both will be taken into consideration early on in your career. That is because there is a strong correlation between the personal credit histories of small business owners to the business credit performance, particularly in the early years of business.
There are basically five pillars that make up a personal credit score. They are as follows:
- Payment History (35%)
- Outstanding Balances Carried On Accounts (30%)
- Length Of Credit Card History (15%)
- Types Of Credit (10%)
- Inquires (10%)
While a spotless record can go a long way in establishing credit, there are several things that can blemish a record. Late payments, in particular, are credit killers, but the following also warrant attention:
- Short Sales
- Late Payments Over 30 Days
- Late Payments Over 60 Days
- Late Payments Over 90 Days
Should you find yourself facing inadequate, or even poor credit, even trivial business matters can prove to be burdensome. Once easy transactions can quickly become more trouble than they are worth. If you have experienced the results of a poor credit score, you may already be aware of the trouble they cause. The duration in which these mistakes impact your score is enough to lose sleep over. Delinquencies may remain on your credit profile for seven years, whereas bankruptcies can cripple credit for as long as 10 years.
Thankfully, there are steps to navigate and repair a poor credit score. While not a fast fix, credit can be rebuilt. It is a meticulous process, but it must be done. Be proactive and fix your credit immediately. As such, the first thing you must do is to determine the reasoning behind the decline. Once the culprit has been identified, take the appropriate steps to fix it. Without fail, one of the best things you can do to repair a poor credit score is to pay your bills on time. Additionally, you may want to minimize your outstanding debt, avoid overextending yourself and refrain from applying for any unnecessary credit. Over time, the cumulative effect of these steps will repair even the worst credit scores.
Due to the nature of the industry, investors are advised against using personal credit during their business transactions. Should the company experience a setback, respective investors are subject to declines in their own credit. Such a regression could be potentially crippling.
Having said that, the purpose of setting up a line of credit for your business is to separate it from the owner’s personal credit. To completely separate the two, you must establish your business as a legal entity that does not hold you personally liable for the debts of the business.
As your business applies for and receives credit, a business credit report will be established. The resulting report will then act as the primary tool for determining whether or not you are approved for future business credit. When a business issues another business credit, it is referred to as a trade credit. It is this type of credit that makes the investing industry revolve, as it is the single largest source of lending in the world.
For more information regarding the establishment of business credit, please reference part two of our Building Credit For Your Real Estate Business series.