Character and past performance matters a lot in the world of lending as every business owner knows. Lenders can only rely so much on personal interviews and evaluation of self-reported background information to judge character, so a personal credit score becomes a proxy. Most banks have hard cut-off points on personal credit scores for small business applicants. CEDF, since it is not subjected to the same kinds of state and federal regulation as banks are, has more latitude to judge a low personal credit score in light of the totality of the applicant’s circumstances.
A new business is unlikely to have any kind of business credit score, just like a young person may have an insufficient credit history to generate a personal credit score. CEDF, recognizing this reality in many of our applicants, relies instead on personal credit scores. And in the early years of a business, practically speaking, this may be much of what matters in seeking financing.
Dun & Bradstreet, historically, was the primary source of business credit scoring. But as the financial technology (fintech) revolution has marched on, D&B has more competition. FICO Small Business Scoring Service now serves numerous banks and the SBA uses this credit reporting product for pre-qualification of 7(a) loan applicants. [SBA 7(a) loans are typically originated by banks.] Experian is another D&B competitor with a similar business score product. And the other two credit bureaus, Trans Union and Equifax, also offer delinquency prediction models.
One might see that as a business grows substantially and its operations begin to dwarf the size and importance of a founder’s personal assets, a business credit score becomes more important for suppliers, lenders and insurance companies. Factors such as payment history, age of credit history, debt levels and usage, company size and industry risk factors are included in some calculations, but like in the personal credit scoring market, there are lots of different scoring models provided by D&B, FICO and the others. And, not surprisingly, personal credit history of the business owners is also included.
But be aware that business credit scores may contain errors, as this Wall Street Journal article explained back in 2013, and because it is harder for businesses to obtain a look a their scores (there’s no FTC Free Annual Credit Report for businesses), these corrections may be hard to make. The Fair Credit Reporting Act does not cover businesses. A lender who uses business credit scoring information (as opposed to personal scoring) does not have an obligation to inform you if you are denied based on that score.
What do you do? If your business is small and new, pay more attention to your personal credit score and do your best to improve it. As your enterprise grows, be known as a solid corporate citizen that pays its bills on time and controls its use of debt. Develop good relationships with banks and respond to the financial benchmarks they use, which are widely understood. Keep aware of changes in the credit reporting industry and how they impact businesses of your size.
Finally, be aware that some fintech companies on the internet that offer a peak at your business credit score are primarily in the business of brokering loans. And their offerings include what CEDF considers the “easy internet lenders” that don’t offer traditional amortizing loans. The effective interest rates of these lenders can get very high and devastating for a struggling small business. It’s still buyer beware on the internet.
— Frederick Welk
CEDF Business Advisor