STRUCTURED FOR CREDIBILITY

Banks and lenders will provide up to ten times more credit to a business client than they will to individuals or a sole proprietorship. How your business is structured is crucial to the credit limit recommendations established in your business credit profile. When reviewing your file, lenders will require certain criteria be met to validate the age, location, and creditworthiness of a company’s profile, even more so if you are seeking credit without requiring a personal guarantee.

How does your legal structure impact your ability to attain business credit?

Many small business owners think they can skate through years in business solely reliant on their personal credit and are, therefore, placing their own company and personal assets at risk. It is not uncommon for small business owners to secure business loans using their personal credit, or to use personal credit cards to purchase office supplies or equipment. Doing either one typically results in those financial obligations being reported in their personal credit history only.

To completely separate your business and personal credit, you must establish your business as a legal entity that does not hold you personally liable for the debts of the business. Structuring your business to appropriately insulate yourself from these personal risks requires foresight beyond opening your doors and getting your first clients. Eventually you will want to expand, grow, or diversify your business. If you wait, you may find out too late that your company is not structured to get high credit approvals or any approvals at all.

The building blocks for business credit are simple, but first you need to understand the various legal structures available for your specific needs.

A sole proprietorship is the most common form of business organization and is usually the simplest to establish. Sole props are owned by one person who is responsible for day-to-day operations. Sole proprietors include full and part-time businesses, individually run businesses or those with employees, and home-based businesses. A sole proprietor will own all the assets of the business and must also take complete responsibility for liabilities and debts.

Partnerships occur when two or more people decide to combine funds and/or talents to create a business. In general, each partner contributes to all aspects of the business including money, property, and labor or skill. Each partner, in return, shares in the profits and losses of the business. Partnerships are generally an inexpensive and easily formed business structure. One advantage is that each partner is equally invested in the success (or failure) of the business. A major disadvantage is that the personal assets of all partners can be used to satisfy the partnership’s debt.

Corporations are independent legal entities owned by shareholders. In short, this means that the corporation itself, as an independent legal entity, is held legally liable for the debts incurred by the business, and not the shareholders. Corporations are more complex than other business structures because they usually have high administrative fees and complex tax and legal requirements. Because of these issues, corporations are generally suggested for larger, more established companies that have several employees.

Limited Liability Companies (LLCs) have specific benefits, including protecting its members’ exposure to liability, such as lawsuits and debts, and provides for “pass through” taxation with the flexibility of a sole-proprietorship or partnership in terms of management and operations. While LLCs protect business owners from extensive taxation, there are still potential tax liabilities for which owners may be accountable — including income tax, self-employment tax and estimated tax. Limited liability companies in many states also are subject to franchise tax.

Of the most common small business designations, only LLCs and corporations provide the legal and financial framework necessary for separating your personal assets from your business finances. Ultimately, how you choose to structure your business will dramatically affect your ability to secure financing and plan for future growth. While each of the above legal structures have their individual pros and cons, you will need to determine which best will suit your needs when it comes to obtaining necessary credit for that growth. It is best if you look at your status as if you were the lender and someone is coming to you for credit for the services you offer.

Lenders will consider your legal structure as a major factor in determining approval amounts, and some legal structure designations may actually hamper your efforts. Because LLCs, by definition, limit the liability of the members, D&B classifies these companies as being in a higher risk legal structure, which can dramatically impair your ability to get the higher dollar approvals simply because the risk for default is borne squarely on the shoulders of the lender or creditor. You can instill more confidence for the lender by proving that you have established satisfactory payment performance with other creditors beforehand, and that process starts with the very first credit lines you establish in your company name.

LESSON: Your legal structure can impact your business credit approvals. You can lessen the risk to future lenders by establishing a strong business credit profile that reflects solid payment performance. Obtain retail and vendor credit, and always make sure to pay your bills on-time, even if there is a dispute about an invoice or service. As those vendors report to D&B, this builds up your credibility and opens doors for additional credit.