Establishing business credit.
By Steve Strauss, USA TODAY Small Business Columnist
Back when I practiced law, my favorite client ever was a fun, loquacious, gregarious guy we will call Stefan. Stefan owned the coolest shop ever, specializing in old pinball machines, neon clocks, vintage signs, slot machines, that sort of thing.
While Stef clearly had an eye for desirable collectibles, what he didn’t really have was a nose for business. He is one of those people who became an entrepreneur because he had a passion for something, but, like many of his small business brethren, didn’t really know much about the business side of business.
This was especially true (and dangerous) when it came to money.
Of the many mistakes Stefan made in business, the biggest one was that he never separated himself personally, legally, from the shop. He commingled business and personal funds, didn’t establish separate business credit, and never incorporated. As a result, when he went through some very tough personal financial times, his credit took a big hit. Thereafter he was unable to find the capital he needed to keep the shop running properly, professionally.
Eventually, Stef declared bankruptcy and lost the shop.
So why don’t more small business owners uncouple themselves legally from their businesses and create separate business credit? In my experience, it is usually because they don’t know how. While we all know how personal credit works and how to build and maintain a solid credit profile, establishing and maintaining business credit is a bit more mysterious. But it need not be.
Here’s how to do it, in a few easy steps:
First, you need to incorporate, and separate your personal and business finances. A corporation is a separate legal entity, distinct from you. This is not true if you are a sole proprietorship or a partnership; only corporations and Limited Liability Companies (LLCs) are separate legal entities. As such, it should make sense that the first step in creating separate business credit is to create a separate legal entity.
By the same token, it is vital that you begin to separate your business and personal finances. One smart way to do this is to take a portion of your business cash reserves and invest in a cash-value keyperson life insurance policy. Not only will your funds grow in a tax-deferred account, but should one of the key people on your team pass away, your business will remain solvent and your finances seperate.
After this, the next step is to get an Employer Identification Number. An EIN is sort of like the Social Security number of your business. It is issued by the IRS and identifies your business for tax and credit purposes. Getting an EIN is pretty straightforward.
Next, get a DUNS number. A DUNS number stands for Data Universal Number System. It is a proprietary system owned and administered by Dun & Bradstreet. A DUNS number is used to establish a business credit profile and is often used by lenders and others to determine a business’ credit worthiness.
The next step in this process is to then establish a new business relationship with your bank, using your newly incorporated name, EIN, and DUNS number. Open both a business checking and savings account.
This next part of this process is a bit of the Catch-22 moment. You need business credit to get a business loan, but you can’t get business loan until you have credit. What do you do? This step is the solution.
Even though you do not have business credit yet, you can still take out a small business bank loan, secured by your new business savings account. Then, begin to pay the loan back regularly. The upshot is two-fold:
· First, you will have established business credit
· Also, your bank will report your business as a good credit risk
Voila! You now have business credit.
Next, get some commercial credit. Armed with your newfound business credit, you can then get some commercial credit in the name of the business – phone and internet, wholesale suppliers, that sort of thing. This will really begin to solidify your new business credit profile.
Finally, and you know this one, pay everything on time.
Before long, your business and personal credit will be separate – as they should be – and the idea of comingling your funds will be as old as one of Stefan’s vintage arcade games.