Raise Capital and Build Credit

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Small Business Borrowing From Your Personal Network

Did you know that lack of a business credit history is the primary reason why many start ups and early stage businesses find it difficult to obtain commercial financing? As an alternative, over half of all small business owners (including some well-known ones like Sam Walton) turn to their personal network of relatives, friends, business associates, etc., and other people they know for private loans. Now, you can use a private loan to build credit for your business.

Here are some of the primary concerns you will need to address as a start-up business:

Do You Need Excellent Credit to Start a Business?

Not necessarily but you'll need to know where to look for funding.

When Richard Branson started Virgin Records (now the Virgin Group conglomerate), he did what most entrepreneurs do: He used his personal
savings, borrowed from relatives and patched together enough funding to pay his bills during the difficult months. He had many of the characteristics of successful entrepreneurs, but what he did not have was excellent credit.

Many entrepreneurs do not have good credit. Some start a business because they were laid off and don't have many alternatives. Some start a business when opportunity strikes, rather than when their personal financial situation is in good condition. Some go through divorces and personal bankruptcies that can ruin their credit.

If you are starting a business and have a poor (or nonexistent) credit history, here are a few tips that should help:

1. Forget big banks as sources of funding. In the past, obtaining bank financing was based on the four Cs of credit: credit history, cash flows, collateral and character. Today, this is no longer true for most large, well-known financial institutions. They care little about three of the four Cs—and instead tend to focus purely on credit history in making lending decisions to small-business applicants. This is because consolidation in the banking industry has driven banks to automate their credit decision processes and
minimize the labor involved in getting to know credit applicants face to face. If you have a great business idea but poor credit history (such as a credit score below 650), you will not get any money from banks. Even if you have a great business idea, a strong character and relevant work experience, you are not likely to get any money from big banks if your credit score is not above the 600 to 650 range.

There is one notable exception to this rule: home equity loans. If you are willing to secure your business loan with personal equity in your home, you will have plenty of options even if you have poor credit. But be very careful about relying on home equity loans too early in the life cycle of your business. Cash flows for startups are notoriously difficult to forecast.

2. Differentiate your personal credit from your business credit. While large banks focus on your personal credit score, smaller community lenders and business-friendly banks will focus on a combination of your personal credit score, business credit score and other factors associated with the viability of your business.

Your personal credit score is determined by several factors, including the outstanding debt balance on personal credit cards, the number of open lines of credit accounts, bill payment history and late payment history. Your business credit score is determined by similar factors but is linked to the tax ID for your business, not your Social Security number. This important difference can help you get your business off the ground.

If your personal credit score is damaged, you should seriously consider getting a separate tax ID number for your business as soon as possible whether you are incorporated or not. If you do not want to spend the money to incorporate your business, you can still get a tax ID number from the IRS even if your business is a sole proprietorship, an LLC or a partnership. Talk to your CPA for information on how to do this. It's very simple to complete the
relevant form (form SS-4) and send it to the IRS. You can apply online at the IRS site.

In addition to getting a tax ID number, it is important to ensure that your business is distinct from your personal identity. You should consider getting a separate business address (not a post office box), a separate bank account, an official corporate name registered with local authorities and a separate
telephone listing. While these administrative chores might seem minor, they are critical in distinguishing you from your business.

3. Build your business's credit score. Once you have a tax ID number and a legal identity for your business, you can start building your business's credit and establishing a means to qualify for trade and credit lines from suppliers and sources of capital.

A growing number of data companies currently track business credit. For example, Equifax has recently developed the Small Business Financial Exchange which provides participating banks with a business credit report. (Click here for a sample.) This report contains information on your business's performance on open lines of credit, including credit cards, installment loans and even loans between relatives, friends and business associates that are reported to Equifax. If you are able to keep these loans on track by making
your payments on time, you can establish a strong credit rating for your business.

There are several other data companies that collect financial information on your business. D&B's PAYDEX score is among the most famous. This score allows your suppliers to know the likelihood that you will be delinquent on a payment. Specifically, the score measures the extent to which payments to your existing vendors have been made on time over the past 12 months. However, keep in mind that most small vendors do not report to D&B. To maximize the likelihood that your business's PAYDEX score is high (more than 70 out of 100), you should focus on paying large vendors who are likely to submit information to D&B.

If you do not have strong personal credit, you should pay special attention to ensuring that you build a good business credit history with companies like Equifax and D&B.

Asheesh Advani is president of CircleLending, a loan administration company that facilitates personal loans, small-business loans, and mortgages. He and his company have written the Small Business Financing Guide for startups and have helped small businesses in more than 30 states launch and finance their growth.

Should You Turn Your Hobby Into a Business?

Five questions to answer before you make the leap from hobbyist to
full-time entrepreneur:

1. How committed are you? Successful entrepreneurs are committed to
their businesses. This is simple to understand, but difficult to put in practice. Are you the type of person who has many hobbies and likes to dabble without commitment? Would you be easily distracted by the next business idea that strikes your fancy? When faced with a task, successful entrepreneurs are generally committed to excel and will not waver when the going gets tough.

2. Is your glass half full or half empty? Not all optimistic people are entrepreneurs, but almost all entrepreneurs are optimistic people. From the owner of the local florist to the founder of a Fortune 500 company, the common thread that runs through the fabric of entrepreneurship is the ability to see a positive opportunity in an otherwise challenging situation. Without confident optimism, it is very difficult to motivate employees, persevere in downtimes and keep your business growing.

3. Do you like to make decisions? Very few of us enjoy making decisions. Decisions mean commitment. Bad decisions lead to problems and can mean losing the respect of one's peers. Owning a business - particularly an undercapitalized startup - is all about making decisions with limited market research and imperfect information. Should you locate the business in your home or incur the costs of a separate office? Should you hire a marketing consultant or a full-time salesperson? How should you price your new products? What should be your first target market for your products? One of the main differences between having a hobby and having a business is the need to make real decisions with financial implications. Will you enjoy it?

4. Do you have the money to make it happen? Once you've written a business plan and established that your hobby can indeed be a sustainable business, the next step is to finance its execution. Unless you thrive on adversity, don't quit your day job until you know that you have sufficient money to fund your business plan. Getting financing is not easy and requires personal sacrifice - whether it involves borrowing from your family's savings, your relatives and friends, credit cards or professional investors. If things don't work out exactly as mapped out in your business plan, will you be able to support a contingency plan to ensure that the business survives? If you don't have the money from your personal network, will you be willing to sacrifice ownership and control to outside investors?

5. Do you like to sell? When I interview candidates for a position at my company, I ask them how they feel about selling. Some of them inevitably shift in their seats and give a half-hearted answer that they do not mind selling when they are asked to do so. Other candidates brighten up and persuade me that selling is a natural part of any job—even if they have never had a sales job. As an entrepreneur, you work in sales. You will have to sell your products, sell your vision for the company and sell yourself. And you will have to do this every day, multiple times. And you will enjoy it - that is, if you are suited to be an entrepreneur.

If you answered yes to most of the questions listed above, you are ready to shift from hobbyist to business owner. If you answered no to most of these questions, and you still want to turn your hobby into a full-time business endeavor, you may want to consider getting a business partner to help you make your plan a reality.