Is bad credit bad for small business startups?
Blemished credit can limit your entrepreneurial success, but it doesn't have to stop it
With roughly 600,000
businesses launching every year, entrepreneurship is, for many, part of the
American Dream. But for those with bad credit, the prospect of business
ownership may seem more like a fantasy than a viable option.
While it's true that bad
credit can hurt your chances for raising money, financial resources are still
available for those who are willing to look for them.
Paula Frendel of Mahwah,
N.J., discovered the perils of starting a business with blemished credit last
year when she launched her personal training firm, Perfect Results By Paula. At
first, she imagined helping clients burn fat and build muscle in her own
fitness studio, but attorneys' fees for her divorce "put me into over
$100,000 of credit card debt," the 57-year-old says. As a result, she had
neither the money nor the credit to buy or rent a business space of her own.
Frendel's credit situation
led her to miss out on other opportunities. Without access to a credit line,
she couldn't afford some large expenditures, such as the $2,000 she'd need to
complete a certification program that would have netted her free advertising
and promotional opportunities to expand her business. Instead, she says,
"I've had to grow it much more slowly."
But the obstacles did not
stop Frendel from putting out her shingle. Since she couldn't afford a business
space, she worked with clients out of her home. To buy the minimal amount of
equipment she needed, she borrowed money from relatives. "What I have been
able to put into the business has been successful," she says.
Lending options limited
Frendel's willingness to be
flexible and work with less are necessary attributes for those trying to start
a business with bad credit
, says Martin Lehman, a counselor with the
SCORE Association, a Herndon,
Va.-based organization that provides education and resources to entrepreneurs.
After all, since the start of the Great Recession, "even those with good
credit are finding it hard to get a business loan," Lehman says.
The best place to start a
search for financing is through loans backed by the Small Business
Administration. "SBA loans are designed exactly for borrowers with less
than perfect credit," says David J. Hall, a spokesman for the SBA. In
addition to a credit score, such loans take into consideration such factors as
the business's viability -- meaning you have to have a business plan -- and any
collateral the borrower has. "However, the SBA would not decline
guaranteeing a loan based only on the lack of collateral," Hall adds.
SBA loans are designed exactly for borrowers with less
than perfect credit.
David J. Hall
Small Business Administration
While the SBA doesn't provide
the funds directly and leaves the lending criteria up to the banks, it
guarantees 90 percent of the loan if the borrower defaults, making the loans
less risky to lenders. As a result, SBA loans tend to have looser requirements.
Someone with bad credit and a good business idea would be more likely to
qualify for an SBA loan than a traditional business loan, Lehman says. Business development
centers that work with the SBA are the best source of information about
lenders who offer SBA loans, but even SBA loans are harder to come by than in
years past. In fact, roughly
half the number of SBA loans were approved in 2009 than in 2008.
Thinking outside the bank
Another financing option
that has become more prevalent during these tough economic times is
microlending. Microlenders solicit small donations and investments from people
and funnel those funds into loans for businesses. "Different microlenders
work with different types of credit situations," says Laura Kozien, a spokeswoman for Accion USA, a microlender based in New
York. For example, Accion USA requires a 575 credit score to receive a business
loan, while Prosper, a microlender based
in San Francisco, requires a credit score of 640.
let investors sift through prospective borrowers to find business owners they
want to invest in, but beyond that, they differ in the details. Prosper, for
example, lets investors bid on the return they want (or interest rate they'll
pay) for filling a particular loan, while Redwood City, Calif.-based Lending
Club sets the interest rate and lets investors determine whether they will
fund the entire loan request or a portion of it. Some, such as Accion USA, will
even report your loan repayment to the credit bureaus, which can help you build
your credit rating.
If microlending and
traditional bank or SBA loans don't pan out, entrepreneurs should look into
funding opportunities with those who know them best -- family members and
friends, says Lehman. Just as you would with an outside lender, spell out to
family members what you're trying to do and what they'll get out of the deal if
they lend their financial support.
"You have a selling job
to do," says Lehman. "Say, 'I'm opening a store, and this is what it's
going to take.' Even offer them a piece of the action, saying, 'If you lend me
$20,000, I'll give you a percentage of the total.'"
Find a way to formalize the
agreement, perhaps by issuing a promissory note with details on when and how
you'll pay the money back. Another tool that could be helpful is ZimpleMoney, a website that helps track the payback process of loans issued by family members
Regardless of the method you
pursue to raise money, don't borrow more than you need. A rule of thumb
suggested by American Express is to take on only debt that directly contributes
revenue to your business. So it might make sense to borrow money to hire key
staff, but it would be a mistake to borrow to buy a better computer when your
current PC still works. The key to starting a business with bad credit is being
flexible enough to build slowly, and as your credit rating improves, taking
advantage of new avenues of funding.
"Even if you don't have
much, you can still grow a business from it," Frendel says.
See related: Small business credit card comparison chart, NSBA: Small businesses hurt by credit card terms, How to keep a small business credit limit from being cut, Pros and cons of using social lending for consolidation
Published: June 24, 2010