Should You Start a Business if Your Credit Isn’t Perfect?

Discover how imperfect credit doesn't have to be a barrier to entrepreneurship, with our insights on starting a business and strategies for overcoming financial hurdles.

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Bad credit and loan applications go together like oil and water—they don’t mix. However, just because you have a poor credit score doesn’t mean that you have to give up on your dreams of starting a company. In fact, you can find multiple ways to get the financing you need to get your business idea off the ground.

When it comes to loan approval, credit scores are one of the most heavily weighted factors. Not only that, but a higher credit score will get you access to more favorable terms and interest rates. Let’s take a moment to learn what your credit score is and how you can improve it.

Improve Your Business Credit Score

Anyone can get a free credit report from Equifax, TransUnion, and Experian. Each bureau uses slightly different methods to evaluate credit. As a rule of thumb, they care the most about payment history and less about credit mixture. 

Your score will fall into one of the following five categories:

  • Excellent: 781-850
  • Good: 661-780
  • Fair: 601-660
  • Poor: 500-600
  • Very Poor: 300-499

Make sure to scan the report for errors that can ding your credit score. Some of the most common mistakes include misattributed identities, incorrect credit limits, and old debts. If you find any of these errors, contact the credit reporting bureaus individually to dispute it. You can get started with this sample dispute letter from the Federal Trade Commission. 

The single best thing you can do for your credit is to pay your bills on time. Timely payments demonstrate to lenders that you are worthy of credit. That’s because past performance is often a reliable indicator of future trustworthiness. 

Late payments can quickly reverse your hard work and lower your credit score. Delinquencies will remain on your credit report for seven years, with recent ones weighing more than old ones. You can reduce the odds of late payment by setting calendar reminders or using autopay at your bank or credit union.  

It would be best to settle as many debts as possible before opening your business. The more debt you have, the worse it is for your credit utilization ratio. While some debts take a long time to repay, such as a car or building, what’s important is that you gradually chip away at the remaining balance. 

If you have your finances in order and are working at clearing your credit record, you might be better off with a personal loan for those with fair credit.

Look at Alternative Forms of Financing

Banks and credit unions are destinations 1A and 1B for business loans. However, if you have less-than-perfect credit, it might not be worth your time to apply. According to Small Business Trends, a good personal credit score to get a business loan is 720 or above. 

If you have bad credit, now is your opportunity to get creative with financing. Two popular strategies are small business credit cards and personal account financing. Research suggests that these two forms account for 25% of funding for budding entrepreneurs.

  • Small Business Credit Cards

Small business credit cards offer a financially flexible way to get started. Credit card companies have lenient credit requirements and make it easy to access several thousand dollars in funding. All you have to do is open an account. 

Most credit cards are unsecured. That means if you default on the loan payment, you do not have to forfeit collateral in exchange. By comparison, a mortgage is a secured loan, which uses the house as collateral. 

Credit cards offset the risk of default with higher-than-average interest rates. According to Experian, the average personal loan has an interest rate of 9.41%, while the average credit card comes with an interest rate of 14.5%, according to 2020 data from the Federal Reserve. If you can’t keep up with payments, you’ll quickly find yourself in a financial hole. 

Some companies offer secured credit cards for people with subpar business and personal credit. These cards often have higher rates than their unsecured counterparts. But at this point, you might not have many alternatives. Paying off your secured business card can help you improve your creditworthiness in the future. 

Tap Into Your Savings Account

You don’t need a finance degree to realize the risks associated with starting a business out-of-pocket. You can afford more risk, though, if you don’t have existing debts. We recommend passing on this option if you are still paying off most of your student loans or personal debts. 

Consider tapping into your savings account for a source of immediate funds. Thousands of entrepreneurs also use their retirement accounts to start a business if they have bad credit. If you meet specific criteria, you can transition the money from your 401(k) or IRA into your new company. 

While self-funding has its risks, it has several upsides, too. For instance, you don’t have to worry about schmoozing with investors or creating polished presentations to woo them. You’ll also have complete ownership and control of your enterprise, which means you’ll retain 100% of future profits.

Apply for a Small Business Loan

As we mentioned earlier, banks and credit unions are probably off the table. If your credit score hovers around 640, though, you should consider an SBA 7(a) loan. The Small Business Administration loan is the most popular way for entrepreneurs to make their business dreams a reality. 

SBA is more forgiving than other financial institutions. The government agency lets people borrow up to $5 million with repayment terms up to 25 years. To qualify, you’ll need to meet the specific criteria: 

  • Meeting the definition of a small business
  • Qualifying as a for-profit organization
  • Being located in the United States
  • Having equity or sweat equity already invested
  • Having no financing from other sources during the SBA application 

Prepare to put down collateral to secure the SBA 7(a) loan. While it isn’t imperative, the SBA may require it if you have bad credit. The collateral serves as an additional security layer in case you can’t repay your loan on time. 

Get a Loan from Friends and Family

If money’s tight, you might turn to friends and family for a helping hand. You wouldn’t be alone. According to one survey, Americans borrow $184 billion from their loved ones each year. The average loan came out to $3,300. 

While obtaining the loan might be more straightforward than going to the bank, it also comes with potential repercussions. If you default on a bank loan, you’re only hurting yourself and your financial future. If you default on your friends and family, you might fray relationships in addition to the economic damage. 

The key is calibrating expectations. Take proactive steps to ensure that your friends and family members are on the same page before agreeing to support you financially. These steps can mitigate the chances of unwanted blowback down the road. 

The first step is to keep expectations low. In fact, your loved ones shouldn’t expect to see their money again. If your business fails, they should consider the money as a gift and have no hard feelings. However, if your business blossoms and grows, their return on investment will be a pleasant bonus. 

Make sure to emphasize that repayments will be slow, if at all. One of the reasons you’re asking friends and family for money is because you can’t get a loan anywhere else. People shouldn’t take these loans as seriously as they would a bank loan, which involves collecting interest and collateral. 

Finally, create a checklist of things that people might ask when you’re raising money. The document gives you an easy way to prepare for tough questions. Some crucial questions to anticipate from donor-investors might include: 

  • How will you use my money?
  • What’s the likelihood of me getting my money back?
  • Why should I trust you with my money?
  • Have you borrowed and repaid loans previously?
  • Who is funding your business? 

Consider Gifts and Grants

Free money is the best money. Best of all, it’s possible to get funding with no-strings-attached when starting a business and having bad credit. Gifts and grants can provide a much-needed boost to your cash flow. 

You’ll need to scour the web to find grants in your city and field. For instance, you have a decent chance of locating funding if you’re starting a health care, tech, or retail company in a low-income area. The SBA also works with various organizations to help channel grant money to small businesses. 

Don’t pin all your hopes on a grant as they can be tough to find and even tougher to secure. There’s a lot of competition to small business funding, so your best bet is to take a multi-pronged approach to finance your company. 

Build Business Credit for Your LLC

Many customers aren’t sure how to build business credit for LLCs. Here are some basic ways to start building credit:

  • Get an EIN
  • Open a business bank account
  • Get an LLC business credit card and pay it on time
  • Establish credit with vendors who report

These basic tips will you gain LLC business credit.

The Bottom Line

If you want to start a business and have bad credit, it’s not the end of the world. Your journey to success might take a little longer. As Inc puts it, “Every entrepreneur starts with a broken credit score.” 

You will find various ways to get the money you need to launch your start-up, including some that we haven’t even mentioned, like crowdfunding and factoring. Try using more than one of these funding methods to see which approach works best for you. That way, you don’t let a bad credit score keep you or your business down.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.

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Written by Team ZenBusiness

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