During the last several days I have been helping a business owner obtain lease financing for a piece of equipment he needs to operate his business. Many business owners don’t understand how their personal credit and business are intertwined.
This is a real-world story about the sole owner of a corporation and how buying equipment has affected his credit.
I am going to call my client Joe. Joe is in his early 40s and has been in the same industry for the last 12 years. He was an employee and subsequently a manger in a competitor company until May, 2008. He owned 25 percent of the company he worked for. During the last 15 years, he has built near perfect personal credit. He saved approximately $200,000 in addition to some investments he had. Last year at this time, his Fair, Isaac & Co (FICO) credit score was about 760.
FICO scores range from a low of 300 to a high of 850. In my opinion, any FICO score over about 750 is irrelevant. With a score of 750 or more, you can obtain pretty much any credit you need. When his score was 760, he had very little outstanding debt on his various personal credit cards and had no late payment history.
Since he was a 25 percent shareholder in another company several years before, he had personally guaranteed several loans and leases for that company. It is customary for banks and lenders to require every 20 percent or greater shareholder to personally guarantee loans. Most lenders report the loan and the payment history on any personal guarantor. Since all payments for those loans and leases were paid on time, the loans made for the business he was part owner in helped raise his credit score and because some of the loans were over $100,000 it showed he could manage a large amount of personal debt.
That is the paradox of personal credit. Credit reporting agencies really didn’t design their systems to accommodate the needs of business owners. What’s worse, the FICO system is being used more often in many banks than a comprehensive review of an individual’s personal credit report. Joe had excellent credit a year ago, but when he began his own business in July of 2008, he had to borrow substantial amounts from banks and other lenders to purchase equipment for the new business.
Since July 2008, Joe has borrowed nearly $400,000 from very conservative banks and leasing companies. With so much credit being reported on his credit report, his credit score has dropped to 610 (an average of all three credit agencies FICO score). A 610 credit score isn’t high enough for him to easily lease one more piece of equipment he needs. He needs to lease one more item costing $110,000. He called my partner because the company he was buying his equipment from recommended that we could probably help.
Each of his three credit reports shows that he has had one late payment in the last 12 months (a Sears credit card with a minimum payment of $10.00). He has had numerous credit inquiries because of applying for credit for his business.
Joe’s company is just starting its busy season, which will last from April through October. Though his company has not lost money so far, it hasn’t yet had enough history to show strong profitability.
Unfortunately, the leasing companies we are talking to don’t normally look at the whole credit picture (i.e. the credit report) for a small leasing transaction of $110,000. If they did, they would look at his debt and realize that understandable for a business of less than one year old. They would see that he has a near-perfect payment history and that there are some impressive banks and leasing companies that have believed in his business plan and his character. My partner’s challenge is to get a leasing company to listen to the whole story, look at the entire credit report, and ignore the credit score, which is low simply because of the amount of credit that has been granted and the number of inquiries he has had from potential creditors.
Because the company is a start-up (less than 2 years old) and because of the nature of how credit scores are calculated, any lease we are likely to be able to find this business owner will be a high-priced lease.
The lesson for business owners is while the system is not perfect; it is the system we have to work with. Until the systems change, a small business owner’s personal credit will always be intertwined with their business. In today’s tight credit market, it is essential to build your business plan around your personal financial ability to handle business debt.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
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EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.