How’s it going, readers—my name is Dave. This is my story. It is focused on explaining to you the importance of and how to build business credit. I’m a real estate investor focused on small multi-family housing: which means apartment buildings of up to ten units. Unless you inherit a gigantic nest egg, one thing you cannot do without in the world of real estate is business credit. But business credit is something you have to develop.
To boil it down, your business credit essentially tells lenders how trustworthy your business is to lend to. And if you’re dealing with purchases that have a six and seven-figure price tag, you’re going to need to seem pretty trustworthy.
Unfortunately, my own relationship with credit was pretty tumultuous. So, let me share my journey with you, and some of the things I learned along the way.
Swiping My Way to Bankruptcy
There was a period of time when I was using credit cards for everything. To make matters worse, I was constantly on the lookout for new deals and bonuses. One card would give me 5% cash back on gas…and a $200 opening bonus. I applied. Another card would give me 3% cash back on groceries…and a $150 opening bonus. I applied. Another bank promised me a credit line of up to $10,000…and a customizable card. Before I knew it, I had about ten different credit cards.
That’s how they get you, of course. Points and cash-back rewards for every purchase make you want to use the card. Even the colors and the look of the card itself encourage some aggressive spending habits. People like you and me are also bombarded with images of credit cards fueling luxurious lifestyles. But the truth of the matter is best summarized by Miss Piggy. Yes, that’s right…Miss Piggy from the Muppets: never eat more than you can lift.
Establishing and managing business credit is a very similar process. You’ve got to build up a history that shows financial responsibility.
Don’t Mix Business and Pleasure
Financial responsibility was something I hadn’t really mastered yet. Credit card issuers had gotten me to the point where instead of building credit, I was building debt. To make matters worse, I was starting to use some of my personal credit cards as business credit cards.
A toilet broke on one of my properties…I rushed to Home Depot and paid for it with my Travel Rewards Card. My Home Depot Card was already maxed out because I had just used it to build myself a deck. On my way over to the property manager to drop off the fixture, I bought myself lunch on the same credit card. I bought him lunch too, figuring the extra $20 was bringing me $3.00 closer to that annual trip to Hawaii.
As you can see, everything was a mess. I couldn’t keep my payment history straight, because everything was a whirlwind of business and pleasure, points and cash back, colors, glosses, and brand names. And against this backdrop of increasingly complicated credit history, all hell broke loose…and it wasn’t just a broken toilet this time.
The Flip That Went Sour
In addition to my rental properties, I was engaged in some home flipping with a few partners. I outsourced much of this work to my colleagues because looking for deals wasn’t really my cup of tea. I was more of a farmer, not a hunter.
In any case, one thing we would do is something called Options Contracts. Sort of like stock options. We would present potential sellers with a contract that could be assigned to a third party before the sale closed.
Basically, to keep a long story short, here’s how it worked: We would go to a seller and offer to buy their home in cash for a certain price. Then we would find a motivated buyer in our network—another investor looking for a fix and flip, perhaps. We’d assign the contract to them, and they’d pay us cash for the house…obviously less than the current owner was selling it—leaving us with the profit between the two numbers.
In order for this to work, these contracts have to contain some very specific legal language. If they don’t, the buyer can get trapped in a situation where they have to pay for the home, even if they haven’t found another investor to substitute into the contract.
There was some miscommunication between my partners and myself over one sale. The date of the sale rolled around and we didn’t have investors lined up on our end. We tried to back out of it, but we couldn’t, legally. To make matters worse, the seller was savvy about real estate law—enough at least to get a lawyer on their side, who sued us for specific performance…meaning, we would have to buy the property.
Foreclosure or Bankruptcy
Suddenly we were down $250,000 in cash, my portion of which was $125,000. Sure, I’m a real estate investor. But I’m no billionaire. Six figures in cash was a serious setback. Because of my credit situation, I couldn’t get any kind of personal loan to satisfy this debt. It was then that I realized I should have been keeping my personal and business finances separate.
As it was, this nightmare happened to occur right at the same time as the 2008 Recession. I had mortgages on a few of my properties, which were now underwater because the housing bubble had popped (meaning, I owed more money on the properties than they were worth).
I was caught between a rock and a hard place: Face property foreclosure or pay my other debt obligation. Obviously, I couldn’t cut off my main supply of cash flow. So instead of facing foreclosure, I filed for bankruptcy.
Rebuilding My Business Credit
Fast forward five years. During that time I couldn’t really expand my business at all. The world of lending in real estate is different from other industries. Private lenders are more willing to extend loans based on the underlying collateral of the property. But because of that one bad deal, I had a hard time rebuilding my reputation among lenders in the area. And of course, the bankruptcy meant that my business credit with institutional lenders was not good.
A lack of credit made things tight. I had to pay for emergencies out of my own pocket. Something had to change. I had to rebuild my business credit. But there’s no way to build business credit fast. Establishing business credit takes time. There’s more to it than searching for the easiest business credit card to get and using it willy-nilly as I did.
Take Yourself Out of the Picture
The first thing you need to do is separate yourself from your business. On paper at least. Although I had never so much as considered it before, I finally set up an S-corp for myself, instead of operating as an LLC. The S-corp had some nice tax implications as well, but that’s a story for another day. This corporation had a separate tax ID number, or EIN, which I used for getting credit for my business.
One thing I would recommend is to speak to a good lawyer who is familiar with the idea of making your assets invisible. While you can register a business yourself, there are ways to do it that really hide you and your personal assets from business creditors.
For instance, you can form an S-corp and make the owner of that corporation an LLC formed in the state of Wyoming—where your personal name is not required for the LLC paperwork. The more you can do to hide yourself, the better off it will be for you. Not only in terms of building business credit but also in terms of asset protection.
How To Use Business Credit Cards: Strategically
This time around, I was more strategic about how to start business credit. Soon, however, I found myself applying for a credit card— the Capital One Spark Classic for business. I monitored my credit reports to see if the business credit profile I was building for myself was improving over time.
However, as I’ll elaborate momentarily, a big part of building business credit has nothing to do with building credit the typical consumer way—through credit cards—and more to do with your relationships in the business world.
In any case, it’s still good to have a business credit card for two reasons: the card can be used for business incidentals—emergency purchases, gas, and food, for instance—and also to build up a credit profile among traditional consumer-facing lenders like banks.
I used the card for business expenses, but never more than 33% of the entire credit line at any given time. All the payments were made from business bank accounts opened up under the name of the corporation. Nothing was tied to my personal finances, my name, or my individual taxpayer identification number. I was no longer confusing my LLC credit card and personal credit cards. The S-corp separation helped tremendously.
The Importance of a DUNS Number
The next thing you need to do is get a DUNS number. This Data Universal Numbering System number is used for getting business loans and grants. The assigner of this 9-digit number is Dun & Bradstreet—one of the three main business credit bureaus. The others are Experian and Equifax (which are also two of the 3 biggest consumer credit bureaus in addition to Transunion).
Getting a DUNS is free through the Duns & Bradstreet Website. You’ll need to provide some basic contact information like your business name, address, and phone number. If your business is at multiple locations, you may need to get a DUNS for each one. You’ll need to provide the name of the business owner, the business structure (LLC, Partnership, S-Corp), the industry, and the number of employees (full and part-time).
Once they have this information, you’ll get a DUNS within 30 days. Although you can expedite that for $229. Once you have this number, you can really start working on your business credit as a separate entity from personal credit.
Note, however, that some creditors will not use a DUNS. When applying for a credit card associated with your business, for instance, they may still request a tax ID number—yet another reason to create an S-corp and get an EIN that is totally separate from your Social Security Number.
Forge Some Relationships: At Least Four
Another thing you can do for business credit building is established trade credit with some of the vendors and suppliers for your business. Check to make sure that these “tabs” are reported to Duns & Bradstreet, Experian, and/or Equifax because they can become useful tools for building your credit. Even if they are not, you can list them as a reference on your application for a loan and the lender—or the bureau that advises them—can follow up to collect data.
In my case, I opened some trade lines with local building suppliers, instead of getting all my supplies through larger vendors like Lowes or Home Depot. These vendors would supply me with whatever I needed over the course of the month—fixtures, appliances, roofing material, paint, carpet, whatever—and at the end of the month I would settle my tab with them.
Business owners who are struggling to get some credit or a loan from an institutional lender can leverage this strategy. Because an individual vendor or supplier may be more willing to take on such an arrangement. Note that in some cases they may ask for a security deposit or some collateral. Which of course, sets them apart from unsecured debt such as a credit card.
Trade References and Your Paydex Score
Trade references may actually be even more important for obtaining business credit than credit card usage. That’s because bureaus like Dun & Bradstreet only factor in trade references for establishing what is called your Paydex Score. This score is assigned on a scale of 1 to 100. Unlike the consumer credit score which falls between 0 to 850.
You need at least four trade references in order to get a Paydex score at all. And these vendors need to be registered with Dun & Bradstreet—so that’s something you should ask about when you start working with a supplier. Many suppliers who are serious about their position in the industry know this and have taken the initiative to register with Dun already.
Yet another thing you can do is to make your payments to lenders early. Not just on time. This is because bureaus like Dun & Bradstreet will only assign perfect Paydex scores to those businesses that make their payments early—and of course, you want to get that Paydex score as close to perfect as possible.
A few things that can facilitate this possibility are negotiating longer payment terms with your vendors. The longer the term, the easier it is to make an early payment. In my case, I was able to negotiate month-long or Net-30 payment terms with my vendors. I was able to pay them early—seemingly very early—and build up my Paydex Score.
Breaking Down Your Paydex Score
The amount of payment is also a huge factor in your Paydex score. Larger payments have more impact than smaller payments, as you might imagine. And recent payments carry more weight than older payments. For these reasons, It’s good to stick with a vendor and build up your order sizes as you build your business.
In my case, over the course of a few years, I added a few small apartment buildings to my portfolio or about 30 rental units. This meant more maintenance and more building supplies. Which meant larger payments to my vendors. Coupled with our Net-30 arrangement, I was bundling what could have been several smaller payments into one larger payment (good) and paying it early (even better).
To break it down a little more, 80-100 is low risk, 50-79 is medium risk, and below that is risky. Remember (again) that the only factor in terms of Paydex Scores is your four trade references—how quickly you pay them and how much the payments are. You can work out arrangements with vendors and suppliers to make it easier for you to build up your business credit. For instance by negotiating longer payment terms. Which not only allows you to pay 30 days early but also make larger payments.
Cash Flow: The Best Offense is a Good Defense
Another thing you can do to protect your business credit is to protect your own cash flow. In my case, I learned this the hard way: when a bad deal suddenly put me short six figures early on in my investing career. The fallout from that bad deal meant I defaulted on my debt obligations. Which put me into bankruptcy.
If you protect your cash flow, things don’t have to go that way. One of your best bets—especially if you’re a landlord—is to automate your cash flow. I found a payment processor, ECS Payments, that was able to create an ACH portal for my renters. They input their checking account numbers, pick the date they want to pay rent (as long as it’s before the 15th), and hit submit. Since account numbers can’t really change like credit cards, my renters are sending in their payments without any kind of interruption, every month.
The only time it’s delayed is if there is an NSF or insufficient funds situation. In these cases, I get one of the family to knock on the door with a baseball bat (just kidding, I don’t do business like that). But I’d say I’ve eliminated about 90% of the late payment issues by getting ECS to help me automate my cash flow.
Protecting my cash flow means that I’m better equipped to pay my debt obligations on time—like my suppliers and vendors. Which in turn, builds up my Paydex Score. Of course, I can also use those funds to pay the debt obligations I carry with traditional lenders, like the bank that issues my credit card.
Consider Taking Out a Loan Before You Need It
Another thing that ECS has helped me with is securing some business funding, proactively. Rather than wait for a roof to cave in (which hasn’t happened yet, but I’m just using a worst-case example) before seeking a loan, I have taken out some cash and set it aside to have cash reserves.
This takes a lot of pressure off me, and the repayment terms are such that the small burden of a very minimal interest amount is far outweighed by the feeling of security I have, knowing that I have cash on hand.
Having cash on hand is also very useful in my line of business in case I ever come across any deals that are too hard to pass up. I have enough to make a very attractive down payment for buildings of up to about 10 units. This means if any landlords in my network are letting something go, I’m immediately poised to pick it up.
Of course, traditional loans are also a great way to build up business credit. My loan through ECS is helping me build my business credit as much as my relationship with suppliers and vendors and my trade lines. So to that end, I’d say that ECS is not only helping me get the business funding I need but also helping me get my business credit in line.
Stay Out of Trouble
One last piece of advice: protect yourself from judgment liens. Pay your mechanics on time. Pay your taxes on time. And in a similar vein, CYA (cover your ass..ets) by structuring your business to hide your ownership as much as possible.
Don’t use one of these generic landlord software options to write rental contracts—have a lawyer do it. Get a good background check system in place for screening tenants. Do everything you can do to prevent judgments on your assets. Because these can mar your credit report.
The end game of this business credit is to leverage it into growth. Right now, over the course of several decades, I’ve grown my portfolio from a small business with a few single-family homes to over 20 small apartment buildings in the greater metro area.
One of these days, I’m angling to go big and get into some commercial or mixed-use buildings. Maybe one of these trendy downtown arrangements where there are retail pads on the ground level and real estate on top. But that’s a rooftop party for another day.