It is commonly known that a business and its owners are separate entities, and thus the personal finance of owners should not have any bearing on the business. Moreover, business credit scores and personal credit scores are calculated differently, so most business owners assume that their personal credit score will not impact their company. While this is true for the most part, a personal credit score is often very important for owners of Micro, Small & Medium Enterprises who are trying to take out loans for their businesses.
What is a Personal Credit Score?
A personal credit score is an important metric that helps lenders determine your creditworthiness. In India, this score is calculated by one of four credit bureaus based on your credit history, the total amount of debt, repayment history, and other similar factors. Your credit score ranges from 300-900, and the higher the score, the better your chances of securing a business loan.
How Does Personal Credit Score Impact SME Loans?
As mentioned above, the company and its owner are two separate entities. However, when individuals want the initial capital to start their own business, their personal credit score determines their business loan eligibility. This is because the company, at this point, does not have any business credit or dealings which a bank or a non-bank financial institution can use to decide if a loan should be approved. Even after a company has begun operations, if a lender does not find adequate information that helps them make their decision, they may consult the owner's personal credit score.
Here are some forms of businesses where your personal credit score matters:
- Sole Proprietorship: In a sole proprietorship or individual entrepreneurship, only one person runs the business. As such, the business owner is by law responsible for any debt incurred by the business. Therefore, lenders deem it essential to check the owner's personal credit score to decide if they will be able to pay back their business loan.
- Partnership Business: Businesses run in a partnership are essentially an extension of a sole proprietorship, putting the business debt on two owners rather than one. In certain forms of partnership like Limited Liability Partnership, owners are only liable for a particular kind of debt. However, lenders would still like to inspect owners' credit scores to analyze their creditworthiness.
- Private or Public Limited Companies: These companies have a larger scale of operations and their own corporate identity. This means the owners or shareholders are not liable for their debt. Therefore, owners’ personal credit score may not have any impact on a lenders' decision to approve a business loan. However, there may be instances when a lender still asks for the owners' credit score as additional information.
This highlights that your personal credit score is linked to your business. In fact, if you end up defaulting on your business loans, it could adversely impact your personal credit score. If your personal score is below 750, banks may often refuse to give a business loan. Small business owners can then attempt to secure loans from other avenues. However, a low credit score means they will have to pay a higher interest rate on their business loan amount. Thus, it is essential to learn how to maintain a good credit score.
Ways to Boost Your Credit Score
- Make Timely Payments: Late interest or EMI payments can impact your credit score. So it is vital to ensure you clear these payments before due dates and don't have any pending payments.
- Don't Take Too Many Loans or Loans that You Cannot Repay: Taking too many loans or a business loan that you can't repay reflects poorly on your credit score and makes lenders doubt your creditworthiness. Moreover, each time you apply for a loan, the bank makes a hard inquiry about your credit score, further decreasing the score. Thus, you should only take loans when needed and ensure that the loan amount does not exceed your income or payment capacity.
- Reduce Your Credit Utilisation: Credit Utilisation is the amount of credit you have used s compared to the amount of credit available to you. It is recommended that you keep your credit utilization below 30%, as using credit above that limit is considered a red flag by creditors and negatively impacts your credit score.
- Don't Cancel Old Credit Cards: Your credit history duration also impacts your personal credit score. So anytime you deactivate an old credit card, your credit score is affected. Furthermore, canceling a credit card also reduces your credit utilization ratio, which could also negatively impact your credit score in the long run.
- Diversify Your Credit: You should also maintain diverse sources of credit, such as credit cards, loans, bank mortgages, as this credit mix also helps boost your personal credit score.
- Keep Checking Your Credit Score: You should keep checking your credit score at periodic intervals to ensure that all new data is being incorporated correctly. Reviewing your score regularly will also give you an idea of how close you are to achieving a good score and what more you need to do to improve it. Several websites can help you check your credit score for free.
Over 36% of SMEs worldwide claim that they have had to resort to alternative sources of finance to fund their businesses. Around 47% of these businesses had to do so because banks refused to provide them loans. Several SMEs have met with discouragement from banks, probably due to their owners' bad credit scores. In such cases, SMEs can always turn to other lenders like non-bank financial institutions for funds. For instance, Shriram Finance is an NBFI that provides loans to MSMEs at competitive interest rates starting from 15%. The loan approval process is hassle-free and requires minimal documentation. Shriram Finance Business Loan eligibility requirements are also quite simple and straightforward. Any small business applying for a loan needs to have an annual turnover of 20 Lakhs or more and a minimum of three years of business experience. You can find more details about the business loan approval process from their website.