Tuesday, June 2, 2015

Credit (Tradecraft)

This is a bit of a rambling post about credit.

We are told early on to make sure our personal finances and our business finances are separate. Commingling is the term to describe the grave offense of mixing your personal monies with those of your business. The basic advice for building business credit applies to us: incorporate (including LLCs), acquire an EIN number, a business bank account, and business credit cards.

After these basic steps, I highly recommend you draw a business salary so you can separate your personal day-to-day finances from the worries of the business. I can tell you there have been several personal financial crises over the years that would have been far worse if the business was in trouble, and the reverse as well. However, when it comes to credit, separating out personal from business is much harder.

There is the myth that once you establish your business and form a corporation, your business will be on the hook for future debts and not you personally. The truth is there is no creditor that I know of who will allow your small business to take on risk without your personal guarantee. This means your personal credit is always a factor with business credit. If you have personal credit problems, you have business credit problems. Worse, it's a double standard, which I'll get to a little later.

Working with creditors in the game trade will help your business, but there is no building up of a business credit history as with your personal credit. Alliance and ACD don't report to Experian that you paid your bills on time in May. My business credit report (yes, that exists) has three creditors on it, despite having over a dozen actual accounts open that would show payment histories of many hundreds of thousands of dollars a year.

This formal credit report is generally ignored by everyone, and in the game trade, your Dun & Bradstreet (DUNS) number is also not considered.  The information on my business credit report is vastly incomplete with the data about annual sales and employees probably reported at various times through our history, the income when I first opened and the number of employees probably seven years ago (we have six now).

My incredibly incomplete and inaccurate business credit report from Experian 

The reason to open business specific accounts is really for separation purposes from your personal credit. Although they'll all require you co-sign on a loan or line of credit, you want to quickly establish business specific lines to keep your personal credit clean. These won't show up on your personal credit report. In fact, they often don't show up anywhere, at least while they're current. The double standard I mentioned is that often your business debts, if they're on your personal credit report, will be judged against your personal ability to pay them back, impacting your personal ability to take out credit.

For example, I have a construction loan that landed on my personal credit report. It's about the size of my mortgage payment and based on my personal income alone, it's impossible for me to make all my payments. I'm an average income individual with essentially two mortgages! Logic plays no role in this, banks just assume that I'm hyper leveraged, since they won't include the businesses ability to make payments. When you've commingled your credit like this, you've done yourself a grave disservice (I'm working to fix this).

Likewise, when I was disputing a fraudulent equipment lease with a credit card processor, my personal credit was dragged through the mud while we came to a settlement. A $45 lease payment by my business grossing hundreds of thousands of dollars a year was hurting my personal credit. The stupidity of that is how many big companies get small businesses to put up with their shenanigans.

The only time I've been asked for my business incomes ability to repay a loan was during the mortgage crisis, when the bank wanted me to have a larger income than I was reporting so they didn't have to consider me for a government sponsored repayment program. They took my business statements and tax forms and showed they had absolutely no idea how to value a business or what a reasonable profit margin looked like. I was wealthy in their eyes, making about three times my actual income. Three times my income wasn't a bad guess if I were working in financial services, as they were. This lack of even a basic understanding of how small business works is probably why banks rarely consider your business success when you're looking for credit.

This puts you in the incredibly frustrating place of having a business income in the hundred of thousands of dollars, yet when you apply for a loan, being treated like you've got the income of a store manager schmo.

It's a common complaint across all small business, and my guess is it has a lot to do with small business default rates. According to my credit report,  the late payment rate in my industry is roughly 20%. That construction loan I mentioned is from a community funding non profit with a default rate of a staggering 10%. That is an enormous number! Credit cards, in general, average 2-3%.

So keep your personal and business credit separate. Keep your nose clean or both will be impacted. Your best bet if you need money is to amass the cash.

No comments:

Post a Comment