Personal Credit for Small Business Owners: Improving Access

There are many things that make lenders anxious about extending credit to small business owners. Factors that could affect your ability to get credit include: your salary history, your earnings, your tax losses, your contingent liabilities and debt exposure, and your experience as a business owner.

You can help alleviate banks’ concerns by doing some or even all of the following:

1. Pay yourself consistently: Banks thrive on predictability. Give them the consistency they crave by paying yourself consistently, week in and week out. This reassures banks by establishing a trendline or baseline for your earnings from which they can extrapolate.
2. Pay yourself a salary: By paying yourself a salary instead of taking distributions in other ways, you will create a “paper trail” for your income (with your W-2s). Also salary income tends to be more consistent -- you’re not going to call ADP and change your salary payroll period to payroll period -- which reinforces point 1. (Paying a salary will subject you to FICA but will also earn you Social Security credits for your eventual retirement -- not a bad thing.)

   How much salary? Use the mortgage rule of thumb: Your salary should be three times the credit you hope to receive. (If you can’t pay yourself that much, you might be looking for too much credit.) Anything over that you can take as nonsalary distributions.

3. Eliminate or reduce contingent liability: Pay down personal debt or debt personally guaranteed for your business to improve your credit profile. (You can pay down nonpersonal business debt later.)
4. Reduce tax loss: This is a balancing act. Reducing tax loss pass-through from your business will increase your tax liability but it will also increase the taxable income you show the bank. If you know you’re going to require a lot of credit in a year or two (such as to buy a new home), consider weaning yourself off of your tax loss pass-through.
5. Be ready with business financials: If your business financials are vital to your personal financials, you can bet the bank will want to see them. Be ready with business tax returns and any other information you’d provide when looking for a business loan.
6. Save more: The less you need to borrow or the more liquid assets you have to support borrowing, the better your chances are of getting credit. It may mean waiting longer, but plan on having more cash in hand as a small business owner than you would as an employee with the exact same annual income.
7. Wait until your business is better established: The longer your business has been in operation, the more secure a lender will feel about it. Similarly, banks feel better if you’re showing a profit, not a loss (see point 3). If you run into lender resistance you may need to pull back and allow time to pass before reapplying.

   What if you haven’t become a small business owner yet? If you’re contemplating starting a business but are currently employed, line up credit now. Establish a home equity line of credit, refinance your mortgage. Whatever it is, do it while you’re an employee with an easily proven salary and straightforward financials.

Steven Zweig, a former SEC attorney and corporate counsel, is owner of Comprehension Publishing. He has an inside perspective on the challenges that small business owners face today.