Establishing Credit For Your New Business

Access To Cash And Credit Is A Business’s Lifeline

Starting a new business can be exciting and stressful at the same time. Once you’ve decided what business you want to be in, the next step is figuring out how you are going to finance the startup.

Access to cash and credit is a business’s lifeline. Business credit allows a company to borrow money that can be used to purchase products or services. It is based on the trust that payment will be made in the future.

Why Establish Business Credit?

For business owners, having a separate legal entity, such as a corporation or limited liability company, provides the unique ability to create a credit identity with business credit reporting agencies, also known as a business credit profile.

A business credit profile is important because it is used by credit grantors to determine whether or not to extend credit to a business. Before you establish business credit for the first time, the first step is to structure your business as a separate legal entity. This is a crucial step in starting a business. The entity you select has legal, financial, and operational implications.

Three Factors To Consider When Choosing A Business Structure

1. Business Taxes

Business owners must meet all federal, state, and local tax obligations to stay in good legal standing. The type of business structure you choose impacts your personal liability and which taxes your business must pay.

For example, choosing a sole proprietorship may be the easiest structure to form for a small business startup, but it comes at a price. A sole proprietorship has less government regulations and tax obligations than all the other business structures. It is taxed at the personal level because you and your business are considered the same legal entity. This means you are personally responsible for all the business’ losses and liabilities.

With an entity structure such as a limited liability company (LLC), business and personal liabilities are separate, like a corporation. Depending on whether you have a single-member or multi-member LLC, you are required to file different LLC tax forms.

2. Industry

Your business structure will depend on the type of industry you operate in because of common practices and state requirements. For example, real estate investment companies carry a higher risk. That’s why the limited liability company is widely used due to the owner’s liability protection it provides.

Typically, companies offering professional services form partnerships because they provide flexibility and are easy to form and maintain. The liability may be limited or unlimited, depending on the type of partnership.

3. Personal Liability

In order to choose the right business structure, you must understand what liability protection each entity structure offers. In a corporation, LLC, limited partnership, and limited liability partnership there are different levels of personal liability protection:

With a corporation or LLC, only the entity can be sued — not the owners or officers of the business.
A limited partnership is created by one or more general partners and one or more limited partners. Limited partners have personal liability for the company’s debts, but only up to the amount they have invested in the business.
In a limited partnership, general partners have unlimited personal liability for the company’s debts. This can be limited by having a corporation or LLC as the general partner.
In a limited liability partnership, all the partners are not personally liable for the other partners. But they all have unlimited personal liability for the business’s debt.

Once you have decided on your entity structure, you will need to apply for a tax identification number, also known as an employer identification number. This is the number used to identify a business entity for tax filing and reporting purposes. Once you have established your separate legal entity and received your tax identification number, you can file for the necessary licenses and permits. With an employer identification number, your business will also be in a position to build a business credit identity with the major business credit reporting agencies.

Now that you have your business properly formed and in operation, the next step is to apply for credit in your company’s name.

In our next post, we will continue this series on establishing credit for your new business by exploring the basic types of business credit you can acquire for your newly formed business with little to no established credit identity.

The Small Business Administration can be a valuable resource for information pertaining to owning and operating a small business. When starting any business, we recommend that you protect your investment by seeking advice from a qualified tax or legal professional.