Navigating Credit Scores for Startup Success

The rate of startups failing due to cash flow problems and other financial issues underscores the importance of good financial management. 

SCORE reported that cash flow is a significant concern, causing 82 percent of small business failures. Cash flow problems can stem from poor financial planning or inventory management issues, among other reasons. 

Lack of funding is also a primary contributing factor. Based on a survey of startup owners, 47 percent of startups didn't work out due to lack of financing. 

Raising money has always been challenging for new business owners, and understanding why is critical to helping your startup succeed. For instance, many are not in an excellent position to ask for a loan due to poor credit scores or insufficient credit history. 

That's likely the case for most startups needing a financial track record. Being aware of this, how can you avoid a similar outcome for your new business?

This article explores the essential role of credit scores in a startup's success. Likewise, you'll learn what goes into calculating your score and practical strategies to improve it. 

Understanding Your Credit Score and Its Role in a Startup's Success

A solid financial foundation is crucial for managing a successful startup. Your credit score plays an immense role in establishing a sound and stable financial base, giving your business the best chance to succeed. 

A credit score represents your creditworthiness. Ranging from 300 to 850, it gives lenders insights into how likely you are to pay back debts and default on loans. Lenders use this three-digit number when assessing loan applications and granting approval to eligible borrowers. 

A high credit score means you're good at managing money and handling debts. It indicates a lower risk of non-repayment, increasing the chances of getting approved for favorable financing terms. Since it reflects financial responsibility, a high credit score also attracts potential investors. 

On the other hand, a low credit score, typically ranging from 300 to 579, can complicate securing a loan from mainstream lenders. Even if you get approved, your options will be limited and can come with higher interest rates and fees. 

It's crucial to note that your business has a separate credit score ranging from 0 to 300. However, without a financial history or business collateral, startups frequently rely on personal credit scores to get started.

Exploring the Factors That Go Into Calculating Your Score 

Your financial history, behavior, and other factors determine your credit score. By exploring what goes into calculating your score, you can get insights into how to build and improve it over time. 

The precise algorithm used for credit score calculations is confidential. But most credit scoring systems assess how you handle credit using the following factors: 

Payment history

How well you've paid your bills in the past often demonstrates if you'll pay your debts as agreed in the future. Since it constitutes 35 percent of the calculation, your payment history is the most critical factor in your credit score. 

Your total debt and available credit

The total amount you owe and how much of your available credit you are using also influences your credit score. This factor is responsible for 30 percent of your score and can change quickly based on what you do. 

Keeping your credit under 30 percent is advisable to maintain a good credit score. It shows lenders you can handle credit without maxing out, making you look more creditworthy.

Length of credit history

Having more experience with credit accounts can help you manage debt better. How long you've had credit makes up 15 percent of your credit score. Therefore, a longer credit history can significantly contribute to a higher score. 

Credit mix and new credit

Taking on new debt can impact your ability to manage your current debts. Applying for new credit and the time since you last opened an account represent 10 percent of your credit score. 

Hence, be careful when considering new credit and ensure you have a clear repayment plan.

Moreover, credit mix accounts for 10 percent of your credit score. It comprises various types of credit, like credit cards, installment loans, mortgage loans, and finance company accounts. Having these diverse credit accounts shows lenders you can manage multiple financial responsibilities. 

Practical Strategies To Build and Boost Credit for Your Startup

Running a startup can be demanding, with many things needing your attention. Among these priorities is strengthening your business's financial credibility, especially if you’re seeking credit to initiate your operations.

Whether you're building credit for the first time or boosting your current credit score, here are some strategies to assist you: 

Maximize credit monitoring

Keeping a close watch on your credit activity is a vital practice for your startup. New businesses are often susceptible to financial risks, causing them to lose money. Actively monitoring your credit can help mitigate these risks. 

As you utilize credit over time, you can see how different factors contribute to your credit score positively or negatively. This information is consolidated into your credit report as you apply for and use loans, lines of credit, and credit cards. 

Mistakes in credit reports are a common occurrence. It can affect your score, causing higher interest rates or rejection of credit applications. With regular monitoring, you can detect these issues and address any suspicious activities promptly before they can lead to further financial harm. 

A credit monitoring app is a valuable tool to track your credit health proactively. It allows you to get weekly updates and alerts about your score. Since it lets you view your financial data in one place, you can efficiently strategize to fix and boost your credit score. 

Open a separate bank account

Opening a separate bank account lays a robust financial foundation for your startup, supporting its growth and success in the long run. 

For one, it distinguishes your startup's financial history from personal finances. This financial clarity simplifies tax filing. It's also beneficial in building a positive credit history for your startup. However, it's important to note that setting up a different bank account doesn't directly affect your credit score. 

Still, doing so allows you to create a financial track record with the bank and position yourself as an existing customer. This familiarity can work in your favor when you apply for credit in the future. 

That can lead to a more favorable assessment of your creditworthiness, helping you secure better rates and terms. Hence, find a bank or credit union that provides the funding you'll need in the future. It could be a small business credit line or business loan. 

Acquire a business credit card

Credit card companies are often the first entities you engage with to build business credit. Whether secured or unsecured, acquiring a business credit card and using it for your startup expenses can help maintain a clear separation between your business and personal finances. 

After setting up credit accounts in your business's name, you must consistently pay your bills on time. Remember, a positive payment history on your business credit card demonstrates responsibility and reliability in handling debts. 

Numerous options exist for new business owners. However, if your primary goal is to establish and boost credit, choose a credit issuer that reports to multiple credit bureaus. A track record of paying timely and using less than 30 percent of your available credit can improve your credit score. 

Selecting a business credit card backed by a deposit account is a strategic financial move for businesses in the early stages. Typically, your deposit sets the credit limit, offering your startup a more stable financial foundation. 

Report timely payments 

Reporting timely payments is an excellent opportunity to build a favorable credit profile. You can use that information to demonstrate your startup's financial reliability. So, how do you report this positive financial track record to credit bureaus?

Suppose you opt for self-reporting. Ensure the payments you make qualify for reporting to credit bureaus. Payments for rent, utilities, and phone or internet services are reportable. Find a reporting service that can incorporate your financial activity into your credit report. 

Alternatively, you can also seek out vendors and suppliers who report payment activities to credit bureaus. You can give two or three trade references and ask them to vouch that you can consistently make on-time payments. 

Financing Options for Startups With No or Poor Credit History

With a limited financial track record, startups often find it challenging to establish creditworthiness. 

Banks typically rely on credit history to assess financial stability and repayment capacity. As such, they may hesitate to extend loans to startups without it.  

Unless your business has survived a minimum of two years, most banks and mainstream lenders won't likely discuss offering you a loan. Even then, they will still examine your personal credit when lending you money. Therefore, having a good credit score remains your best option. 

Suppose loans from banks and traditional lenders are out of the question. In that case, you can explore other funding sources. Below are some alternative forms of financing for startups with no or poor credit history:

Microloans

This alternative financing gives small loans to small and new businesses struggling to get working capital from conventional loans or credit cards. 

The criteria for microloans are not stringent, making them an excellent option if your credit score falls short for a loan from the bank. Since microloans are short-term, paying them back quickly can boost your credit score. That can help you qualify for a traditional loan in the future. 

Guaranteed loans

A guaranteed loan is when a third party agrees to cover the debt if the business can't repay it. Since this arrangement lowers the lender's risk, your startup can obtain financing more easily without a track record of trading or generating revenue. 

Compared to other types of loans, a guaranteed loan often comes with more manageable repayment plans. That makes them a popular choice for startups seeking financial resources to fund their business. 

Crowdfunding

Crowdfunding is another way to acquire funds for your business if you can't get a traditional loan or want to avoid paying the high costs. 

It involves raising money from different investors online through a crowdfunding platform. All you need to do is create a profile for a business and decide the target amount you want to raise. Once the goal is reached, you'll obtain the money, and investors typically receive a small share in the company. 

Establish Your Startup for Long-Term Financial Success

Startups offer significant potential for profits. However, they often require substantial investments before becoming operational. This underscores the importance of protecting your credit score. 

Maintaining a good credit score is an excellent starting point for running a business, especially for startups. Besides helping you secure the funds necessary to build and grow a business, it also empowers you to build trust with partners and suppliers. 

Thus, make credit monitoring a key component of your business plan. With access to more favorable terms and interest rates, you can establish your startup for long-term financial success. But it's equally vital to remember that the process isn't one-time. It requires ongoing effort and attention.