Almost every business owner, at one point or another, will need some extra funding to help make ends meet. It might come early in the life of their business, when they need help getting the business off the ground. Or it might come after many years, when an opportunity for expansion or need for renovation arises. Many businesses turn to debt financing, also known as business loans, to secure this funding.
The best business loan options, however, are for well-established businesses, run by business owners with excellent personal and business credit scores. Good lenders, such as banks, are hesitant to lend to unproven small businesses.
The irony is that the best way to improve your chances of acquiring affordable financing is by using other financing products and working your way up. If you’re a new small business owner with a limited credit history, here’s how you use business financing to improve your credit score.
Build good habits with secured and unsecured credit cards
The first step in building a good credit score is to get yourself a business credit card. There are tons of options on the market, and nearly every business owner will qualify for one product or another.
Business credit cards are helpful beyond being a source of short-term financing: many of them come with perks, such as purchase protections or reward points you can use to reinvest in your business.
But using your business credit card to make purchases and pay them off slowly but surely builds your credit score as well. You have two options in this regard: using a secured credit card or an unsecured credit card:
- Secured credit cards. These are designed for building credit if your credit score is bad. You submit a deposit to the credit card issuer and essentially borrow money off of that deposit. This mitigates the risk the issuer takes in lending you money, and you display your ability to borrow and repay.
- Unsecured credit cards. Once your credit score has improved enough, you can qualify for an unsecured business credit card, which is the typical credit card most people have. You have access to a pool of funds that you draw on and repay as needed — without “securing” your draws with any sort of collateral.
Continue to use your credit card on a regular basis, and you’ll build a credit history that will make you eligible for better products.
Establish credit accounts with suppliers, if possible
If you have good relationships with your suppliers — manufacturers who provide your inventory, for example — you can ask to create a credit account with them. From then on, you’ll receive your inventory first and pay for them later, which is a form of short-term financing.
Your supplier may share client payment data with business credit-reporting agencies or you can add your credit account yourself. Adding another credit account with an excellent payment history is another way to prove your creditworthiness.
Increase your overall credit limits
One of the most important factors credit bureaus consider when building your credit score is your credit utilization ratio. That’s the amount of credit you use relative to your overall limits.
To improve your score, you should keep your ratio low. There are two ways to do that: consistently pay off your purchases so your credit use is minimal and increase your limits by opening up new credit lines.
You can do that by acquiring another business credit card, opening up a business line of credit (more on that in a moment), or asking your current credit issuers for an increase.
Even if you don’t ever come close to using all your available credit — well, that’s the point. Lenders don’t want to see that you’ve already maxed out your credit limits by the time you apply for a loan from them.
Upgrade to a business line of credit
A business line of credit (LOC) is a financing product offered by most lenders. It’s like a credit card: you get access to a pool of money, and you can draw from that pool at will up to your credit limit. You pay interest on what you’ve drawn, and it can sit also dormant without you paying another cent for immediate access to it.
Unlike credit card, LOCs don’t come with reward points or other perks. The spending limit, however, it much higher — as much as millions of dollars per line.
This kind of flexibility, combined with the large spending limit, makes LOCs one of the most sought-after financing options on the market.
Of course, the best business lines of credit with the lowest interest rates require high credit scores, among other factors. But just qualifying for a line can improve your credit utilization ratio and, by extension, your credit score. Plus, using your line and repaying it responsibly also reflects well on your credit history.
Obtain, and pay off, elite business loans
At this point, you may become eligible for some of the best small business financing options of all, including SBA loans. Financing through the Small Business Administration’s loan program is some of the most affordable on the market, with single-digit-interest rates and repayment terms lasting 10 years or more.
Every SBA loan product requires a personal credit score well over 600, and for some products you’ll need a score that at least approaches 700. Not every situation is the same, so two business owners with credit scores of 680 and 650 might both qualify for the same SBA loan. But you’ll want a score that is as high as possible, to go along with a strong proven revenue stream, at least a few years in business, collateral, and other factors.
Obtaining and paying off these types of loans will put you in excellent business credit score territory. Paying off an SBA loan may even make you eligible for traditional bank loans without an SBA guarantee, which means you’ll qualify for the best business loans possible. It doesn’t get much better than that.
There is a relationship between good loan products and good credit scores and bad loan products and bad credit scores. If you have a low credit score and you settle for a predatory loan, you’ll be less likely to be able to pay it off, further hurting your score and your chances of obtaining something better.
On the other hand, starting with responsible financing choices like a secured credit card puts you on the path toward better and more affordable loans. It may seem like a long road, but there are no shortcuts to proving your creditworthiness to lenders. And the payoff, in the end, will be worth it.
Eric Goldschein is an editor and writer at Fundera, a marketplace for small business financial solutions. He covers entrepreneurship, small business trends, finance, and marketing.