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How Building Business Credit Can Protect Your Personal Credit
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The financial decisions you make throughout your life shape your personal credit profile, which affects how financial institutions view you as a borrower. As a business owner, you have an additional credit profile to worry about.
While building business credit may seem daunting when starting from scratch, it can ultimately help you protect and preserve your personal credit score. If you don’t have significant business history, lenders will rely on your personal credit background when approving you for financing. To detach your business activity from your personal credit, you’ll need to establish a strong business credit profile.
We’ll walk you through a few steps you can take to start the foundation for your business credit profile so you no longer have to put your personal credit at risk.
The importance of building business credit
Your business credit reflects your financial history as a business owner and affects whether or not lenders would be willing to let you borrow money. Maintaining good business credit would help you obtain financing from a bank or alternative lender without having to rely on your personal credit history, said Barry Coleman, vice president of counseling and education programs for the National Foundation of Credit Counseling. The better your business credit, the less risky you become as a borrower.
“Those are the types of customers banks and credit issuers love,” Coleman said.
A positive business credit profile could help you secure more favorable interest rates and terms on small business loans or credit, Coleman said.
Business owners should create separate checking and savings accounts to handle their business and personal expenses, Coleman said. Separating your expenses would help you maintain both your business and personal credit scores. Before building up business credit, you have to rely on your personal credit score to obtain financing. It’s important not to let either credit score fall by the wayside, Coleman said.
Your business credit score not only reflects your financial activity, but it also indicates your overall performance as a business owner, said Anton Goddard, president of the South Atlantic branch of the National Association of Credit Management. If you are irresponsible with your finances, it could damage your reputation among banks and lenders.
“That information is openly shared,” Goddard said. “Everybody in the credit industry remembers the bad names.”
Protecting your personal credit score
As you build your business credit profile, you would have to provide your personal information when filling out financial applications, especially for business credit. New entrepreneurs usually must provide a personal guarantee to obtain a business credit card, Goddard said. A personal guarantee is a legally binding agreement that makes you personally liable to pay back debt.
Providing a personal guarantee when applying for business credit would make you, rather than your business, responsible for paying the balance. A personal guarantee would also link all of your card activity to your personal credit profile and wouldn’t make any impact on your business credit, Coleman said.
When you apply for a business credit card, the card issuer will require you to provide business information such as revenue, years in business and number of employees to determine your risk level, Coleman said. The issuer needs to determine if your business is dependable enough to be liable for debt.
“Someone starting out may have some of those things, but they wouldn’t have much business revenue,” Coleman said. “That’s where the bank would lean on the personal guarantee a little more.”
Once you’ve been in business for a couple of years and have a track record to prove you’re worthy of business credit, you would no longer need to provide a personal guarantee.
You can be released from a personal guarantee, Coleman said, but you would need to convince your bank of your improved creditworthiness. You would need to present financial statements from the past two or three years, realistic business plans for the next few years, strengths and weaknesses of your business and a plan to address those weaknesses, Coleman said. You may also have to provide alternative collateral to use in place of the personal guarantee.
How to build business credit
Open accounts with your business ID.
To establish business credit, you need to obtain an Employer Identification Number from the IRS after formally registering your business with your local authorities, Coleman said. Your EIN acts as an identification number for your business and should be used any time you apply for credit or a bank account.
“In order for business credit to be established or calculated, they have to have accounts in the name of the business,” Coleman said.
Using your EIN in place of your Social Security number would link your financial activity to your business rather than your personal credit profile, Coleman said. Your business credit profile will become more robust as you continue to use your EIN.
Don’t bother with business credit cards.
Credit cards are often good tools to build your personal credit score. Using them responsibly boosts your credit profile. However, business credit cards do not impact your business credit in the same way, Goddard said.
Business credit reporting agencies differ from the three standard consumer credit reporting agencies, Equifax, Experian and Transunion, Goddard said. Popular business credit reporting agencies include:
- Dun & Bradstreet
- National Association of Credit Management
Business credit agencies do not all collect the same information, and your business credit report could vary based on which agency it comes from, Goddard said. Major credit card companies like Visa, Mastercard and Discover often do not report activity to these agencies, Goddard said, which doesn’t do your business credit profile any favors.
Start small with store credit.
Small business owners would have a better chance of building business credit with companies that offer lines of credit, Goddard said. Those companies often report financial activity as trade information to business credit reporting agencies.
“That trade information is really what builds that credit report,” Goddard said.
Supply stores like Staples, Office Depot and Lowe’s — or local suppliers — offer credit to business owners. Although credit would be limited to those merchandisers, it’s a good starting place for business owners to build their credit profile, Coleman said.
“They may have to start out small and realize they can take steps to create a positive business credit history,” Coleman said.
When you apply for credit from a supplier, you should ask which business credit agency the company reports to, Coleman said. It’s your responsibility to check with any credit issuer to make sure they report your activity.
“If you’re following positive credit practices and it’s not being reported, it’s not really helping you out in that regard,” Coleman said.
The bottom line
As a new business owner, you’ll likely have to rely on your personal credit history to secure any type of funding. But as your business matures, you should be able to leave those personal guarantees behind, as long as you take care of your business credit profile.
Taking out credit with your preferred suppliers would be a small but effective starting point to build business credit. Once you have those credit lines open, be sure to keep your balances low and make payments on time or early, Coleman said. Paying off your balance in full each month would be a smart move as well.
“That will help quite a bit,” he said.
Following responsible money management techniques would allow you to build a strong business credit profile so you would no longer have to rely on your personal credit and pose threats to your score. Owners have an easier time applying for business financing if their business credit profile is in good shape, Goddard said.
“When they apply for new credit and somebody pulls their business credit, they’re going to get their materials quicker, get a better price,” Goddard said. “It’s also going to save them a lot of time.”