Small businesses are the foundation of the US economy. They contribute to job growth and nearly 45% of US GDP. However, business success, in part, requires securing adequate funding to grow and scale. It’s often the make-or-break factor for startups and small businesses. At the heart of this financial challenge lies the quest for business credit. It’s a vital resource that can fuel growth, manage cash flow, and turn entrepreneurial dreams into thriving enterprises.
Whether you’re a budding startup or an established small business looking to expand, understanding the path to securing small business credit is crucial for success. In this article, we list the challenges for securing small business credit and highlight strategies to secure business finance successfully. Let’s dive in.
1. Business Formation in the United States
Business creation in the US is at an all-time high. In 2023, over 5.4 million businesses were created in the US, a 57% increase from 2019. Across multiple regions of the US, many opportunities exist to start and grow a business. However, access to funding is important.
Before pursuing business credit, it is essential to lay the proper groundwork through careful business formation. Establishing the right business structure will affect your day-to-day operations, impacting your ability to secure business credit and manage finances effectively.
1.1 Sole Proprietorship
The simplest form of business structure, a sole proprietorship, offers complete control to the owner. However, it also means bearing total liability for all business debts and obligations. While easy to set up, this structure can limit your ability to build business credit separate from your personal credit history.
1.2 Partnership
Partnerships involve shared ownership between two or more individuals. They can be general partnerships, where all partners share management and liability, or limited partnerships, where some partners have limited liability and involvement. This structure offers more flexibility in management and profit-sharing but can complicate credit-building efforts.
1.3 Limited Liability Company (LLC)
An LLC combines elements of corporations and partnerships, providing personal asset protection while maintaining management flexibility. The LLC structure makes establishing business credit easier than sole proprietorships or partnerships. It creates a clear separation between personal and business finances.
1.4 Corporation
A corporation offers the strongest personal asset protection as a separate legal entity from its owners. While more complex to set up and maintain, this structure is often advantageous for building business credit. Corporations can more easily establish creditworthiness independent of the owner’s personal finances.
When deciding on your business structure, consider liability protection, tax implications, and long-term business goals. It’s advisable to consult with a business attorney or accountant to determine the best structure for your specific situation.
2. Challenges Faced by Small Businesses
Understanding small businesses’ hurdles is crucial when approaching lenders for credit. These challenges often factor into the risk assessment process and can impact your ability to secure favorable terms. However, many affordable solutions exist today to help small businesses overcome challenges. Below are the major challenges faced by small businesses and some suggestions to overcome
2.1 Limited Access to Capital
Many traditional lenders hesitate to work with startups and small businesses due to their perceived risk. Proving creditworthiness without an established business history can be an uphill battle.
2.2 Cash Flow Management
Balancing incoming revenue with outgoing expenses is a constant challenge for small businesses. Seasonal fluctuations in income can further complicate cash flow management.
2.3 Market Competition
Standing out in crowded markets and competing with larger, established businesses requires strategic planning and often significant financial resources. Companies such as Semrush help enhance their online visibility, improving lead generation and sales.
2.4 Regulatory Compliance
Navigating complex federal, state, and local regulations can take time and effort, particularly for small businesses with limited resources. For those just starting,
2.5 Economic Uncertainties
Small businesses are often more vulnerable to economic downturns and must be agile in adapting to changing consumer behaviors.
2.6 Talent Acquisition and Retention
Attracting and retaining skilled employees can be challenging when competing with larger companies that can offer more competitive compensation packages. PEO and Payroll providers offer alternatives to create flexibility in hiring, allowing you to grow and shrink your business.
2.7 Technology Adoption
Keeping pace with rapidly evolving technology is essential but can strain limited budgets. However, building an affordable tech stack with common tech solutions can create an advantage.
3. Common Funding Sources for Small Businesses
Small businesses typically rely on various funding sources to meet their financial needs. Understanding these options can help you determine the best approach for your business.
3.1 Personal Savings
Often the first source of funding for startups, using personal savings demonstrates a commitment to potential lenders.
3.2 Friends and Family
While this can provide flexible terms, managing these friends and family lending arrangements is essential to avoid straining personal relationships. Have clear and arm’s length agreements in place with friends and family.
3.3 Small Business Administration (SBA) Loans
Government-backed loans offer favorable terms and various programs tailored to different business needs. The Small Business Administration offers many lending programs, such as loans and grants. You can learn more here.
3.4 Traditional Bank Loans
These can offer competitive interest rates but often require a strong credit history and collateral.
3.5 Business Credit Cards
Convenient for short-term financing and building credit but typically comes with higher interest rates than traditional loans. Credit scores and operating history are important.
3.6 Angel Investors
Individual investors who provide capital in exchange for equity can bring valuable expertise and connections. Angel investors will typically invest in high-risk, high-growth early-state enterprises. You can find out more here.
3.7 Venture Capital
Suitable for high-growth startups but involves giving up a portion of ownership and control. Venture capital will often invest at a later stage than Angel Investors.
3.8 Crowdfunding
Raises small amounts from many people, potentially serving as market validation. There are many websites. Kickstarter and GoFundMe are more popular platforms.
3.9 Invoice Factoring
Selling accounts receivable at a discount for immediate cash is helpful for businesses with long payment cycles. There are many independent providers. However, it is important to check the fees.
3.10 Equipment Financing
Specific loans for purchasing business equipment, using the equipment itself as collateral. Both traditional banks and independent companies offer this service.
4. Building Business Credit
Establishing a solid business credit profile is crucial for accessing better financing options and terms. Here are vital steps to build your business credit:
4.1 Obtain an Employer Identification Number (EIN)
An EIN separates your business identity from your personal one. Most business applications require an EIN. An EIN can also be acquired for foreign residents seeking to establish a business in the United States. Consult with companies such as Firstbase.io to learn about the process for registering your company
4.2 Register Your Business
Choose an appropriate legal structure and comply with state and local registration requirements. Be selective on the jurisdiction, as Delaware, Nevada, Wyoming, etc, have advantages and disadvantages.
4.3 Open a Business Bank Account
Keep business and personal finances separate to demonstrate financial responsibility to lenders.
4.4 Establish Credit Accounts with Suppliers
Start with net-30 accounts to build initial credit history, ensuring suppliers report payments to credit bureaus.
4.5 Apply for a Business Credit Card
Use it responsibly and pay balances on time to establish a credit utilization history.
4.6 Monitor Your Business Credit Reports
Regularly check reports from major business credit bureaus and dispute any errors promptly.
4.7 Maintain Good Payment Practices
Pay all bills on time or early and keep credit utilization below 30% when possible.
4.8 Diversify Your Credit Mix
Use a combination of revolving credit and installment loans to demonstrate the ability to manage different types of credit.
5. Criteria Banks Use to Determine Business Credit
Understanding the factors lenders consider when evaluating business credit applications can help you prepare a more robust application:
5.1 Business Credit Score
Ranges from 0 to 100, with higher scores indicating lower risk. Factors determining a business credit score include payment history, credit utilization, and public records.
5.2 Personal Credit Score
It is especially important for new businesses; it demonstrates the owner’s financial responsibility.
5.3 Time in Business
A longer operating history is typically viewed favorably. New businesses may face stricter requirements.
5.4 Industry Risk
Some industries are considered higher risk than others, which may affect loan terms and approval odds. Some of the high-risk businesses for loans include construction, technology, commodities, etc.
5.5 Annual Revenue
Indicates the ability to repay the loan. Lenders often have minimum revenue requirements.
5.6 Profitability
Demonstrates business sustainability, though it may be less crucial for startups with strong growth potential.
5.7 Debt-to-Income Ratio
Measures current debt obligations against income, with lower ratios preferred.
5.8 Collateral
Assets that can secure the loan, reducing risk for the lender.
5.9 Business Plan
Outlines growth strategy and financial projections, demonstrating planning and market understanding.
5.10 Cash Flow
Shows ability to manage day-to-day expenses and debt payments. Positive and consistent cash flow is ideal.
6. Location and Address Considerations
The location and address of your business can play a significant role in credit decisions. A professional business address is preferred. Consult with companies such as Alliance Virtual Offices, as they provide some of the best business addresses in key business centers worldwide.
6.1 Business Stability
A permanent physical address is viewed more favorably, while home-based businesses may face additional scrutiny.
6.2 Local Economic Conditions
Lenders may consider the economic health of your area, with high-growth regions often viewed more positively. Key growth areas in the US include the Southeast, Southwest, and Texas areas.
6.3 Industry Concentration
Some areas may be saturated with similar businesses, making unique offerings in your location advantageous.
6.4 Zoning Compliance
Ensure your business location is zoned correctly, as non-compliance can raise red flags for lenders.
6.5 Accessibility
Easy-to-find locations may be viewed as lower risk. Consider the impact of foot traffic on your business model.
6.6 Lease Terms
Long-term leases indicate stability to lenders, while short-term or month-to-month arrangements are riskier.
6.7 Property Value Trends
Rising property values in your area can be a positive sign while declining values might raise concerns about local economic health.
7. Tips for Securing Business Credit
To maximize your chances of securing business credit:
7.1 Start Early
Build business credit as soon as possible to establish a strong credit history.
7.2 Separate Personal and Business Finances
Use business accounts for all business transactions to establish a clear financial picture for lenders.
7.3 Maintain Accurate Financial Records
Keep detailed books and prepare regular financial statements to demonstrate financial responsibility and organization.
7.4 Build Relationships with Lenders
Establish accounts with local banks or credit unions and nurture relationships even before you need credit.
7.5 Consider Alternative Lenders
Explore options with online lenders and fintech companies, which may offer more flexible terms.
7.6 Prepare a Strong Business Plan
Clearly outline your business model, market analysis, and financial projections to show lenders you’ve done your homework.
7.7 Be Transparent
Address any past financial issues upfront and explain your plan for overcoming challenges.
7.8 Start Small
Begin with smaller credit lines and build up to demonstrate responsible credit management over time.
7.9 Leverage SBA Programs
Explore SBA-backed loans and resources, which can provide more favorable terms for small businesses.
7.10 Seek Professional Advice
Consult financial advisors or small business mentors for expert guidance on improving your creditworthiness.
Conclusion
Securing business credit is a critical step in the growth and success of any startup or small business in the United States. By understanding the intricacies of business formation, recognizing common challenges, and familiarizing yourself with various funding sources, you’ll be better prepared to navigate the complex credit landscape.
Building a strong credit profile takes time and consistent effort. Focus on establishing a solid foundation, maintaining best business practices, and strategically leveraging available resources. With persistence and intelligent planning, you can position your business for long-term economic success in the competitive US market.
As you embark on your journey to secure business credit, remember that each business’s path is unique. Stay informed about changes in the financial landscape, be prepared to adapt your strategies as needed, and don’t hesitate to seek expert advice when facing complex financial decisions. With the right approach and a commitment to economic responsibility, you can unlock the funding needed to turn your entrepreneurial vision into a thriving reality.
To discuss ideas for your small business or funding options, contact our team at ClearSky 2100 Ventures.
Disclosure: At ClearSky 2100, our portfolio partly consists of affiliate partnerships. We may earn a small commission from buying links on our site at no cost to you.
