Featured Expert
Priyanka Prakash
Priyanka Prakash Finance Specialist, Fit Small Business View bio

This guide was written by

Zina Kumok

Imagine you’re starting your own business. You’re excited about your idea, you’ve created a solid business plan, and you have the support of your friends and family. There’s just one problem: you have bad credit.

In a world where credit approvals are determined by algorithms, a bad credit score can feel like a dead end, even more so when you have a business to get off the ground. But bad credit doesn’t mean you’re shut out of business lending options; it just means you’ll have to work a little harder to get the same financing that your peers have.

Credit Meter

The good news is that you can use it as an opportunity to fix your past mistakes. You just need to rebuild your credit until you can qualify for a microloan or some other type of financing. There’s no reason to despair. You aren’t the first business owner with bad credit to apply for a loan —and you won’t be the last.

Financing Options for Bad Credit

Even with bad credit, you may still qualify for a bank loan, but you’ll just have to pay higher interest rates than those with better credit scores. If you can’t secure a regular bank loan, here are some other options.

Borrowing from Friends and Family

Borrowing money from your loved ones may be an overlooked option, but it’s a relevant choice for many business owners with bad credit. For the sake of your relationships, don’t pressure anyone into lending you money and draw up contracts that detail how much you borrowed, when you’ll pay it back and what kind of interest you’ll pay the lender. The IRS expects there to be interest on these loans and if there isn’t, the lender could face tax repercussions. You’re not required to charge interest if the loan is less than $10,000, however.

Microloans

Microloans have become famous for helping business owners in developing countries can get access to credit. But they’re also an option for local entrepreneurs who don’t have the credit score necessary to access a business loan. Many business owners with bad credit have to bypass traditional business loans in favor of opportunities such as microloans. Microloans are usually relatively small amounts of money with short terms and low interest rates.

Revenue-Based Loans

In exchange for an investment in capital, borrowers pay the lenders with revenue from the business. A percentage of revenue is paid back on a regular basis so the payments will differ from the month to month, depending on how well the business did. This is beneficial for business owners whose payments will be lower in slower months and higher when times are good, but these loans also tend to have high interest rates.

Alternative Web-Based Lenders

Alternative lenders are popular for business owners with bad credit because they tend to be more willing to lend money. Interest rates will likely be high, but that should be expected when you have bad credit. Lenders abound online so do your research, find objective reviews and make sure to read the terms and conditions carefully so you’re not stuck with high fees.

Accounts-Receivable Financing

This type of financing happens when a business sells the rights to collect on invoices as collateral to a financing company. You can receive anywhere from $50,000 to $1.5 million, depending on what your needs are. The more you invoice, the more money you can borrow. It’s not technically considered a loan; it operates like a cash advance, similar to what you might receive in a traditional workplace if you ask for an advance on your paycheck.

Asset-Based Loans

Like its name, asset-based loans are ones that are secured by hard collateral or assets, such as real estate, luxury items or stocks. Because these are secured loans, they often have better interest rates than unsecured loans (which may even be unattainable for those with bad credit).

Merchant Cash Advance

A merchant cash advance is like someone lending you money in exchange for equity in the business. One of the hallmarks of a merchant cash advance is that you have to make smaller, more frequent payments to the lender based on your incoming revenue from purchases. Usually these are structured so the lender receives a portion of the business that you take in every day. These typically require less work than getting a business loan and are given out based on the strength of the business, not the owner’s credit score. However, cash advances have a high APR, high fees, no grace period for interest and other risks.

How to Improve Your Chances of Getting a Loan with Bad Credit

While it may be difficult to get a loan with bad credit, it is not impossible. Seek out lenders who specialize in borrowers with bad credit.

It will likely help to have a co-signer willing to back your loan. This should be someone with good credit who could theoretically afford to pay back the loan in case you or the business become insolvent. You should also look at secured loans and those with collateral or assets tied to them. You’ll have a better chance of qualifying for these and they will have lower interest rates than unsecured loans.

After you get the loan, continue to work on improving your credit score. Not only will that help you when looking at new lending options, but you may decide to refinance your business loan and get a lower interest rate.

Use this new loan as a way to repair your credit score. Make your payments in full and on time, and stay on top of any potential issues. If you find yourself having cash flow issues, contact your lender as soon as possible. They may be willing to work with you if you go to them before you miss a payment.

Improving your credit score to become eligible for business funding is not unlike improving your score when you’re applying for a mortgage or car loan.

Here are some basic strategies you can use:

Minimize the percentage of credit you use

One major factor in your credit score is how much credit you’re utilizing. Credit bureaus like to see that you only use 30 percent or less out of the total credit you have available to you.

Dispute any incorrect or negative information

Collections, defaults, and late payments can show up on your credit report, lowering your score and your desirability to lenders. If there are incorrect items, send a letter to the credit reporting company to see if you can get them removed from your report. The Fair Credit Reporting Act requires most negative information to be removed after seven years.

Avoid opening any new lines of credit or loans

New inquiries and loans hurt your credit score because they drag down your overall credit age. Lenders like to see an old credit age, which is calculated by the average age of each of your accounts. New accounts bring down the average.

Have a variety of credit on your report

Credit bureaus like to see that you have different types of loans and credit available to you. For example, a good mix may include a couple of credit cards, a mortgage and a student loan. That’s not to say that you should go out and take out a loan specifically to diversify your credit, but a lack of diversity may be one reason why your score is low.

Make your payments on time

Late payments and defaults will show on your credit score that you’re not a trustworthy borrower. Keeping your payment history in check will help increase your credit score and show that you’re responsible.

Be cautious

Don’t let bills stack up and don’t borrow more than you feel comfortable taking out — even if you qualify for more. Once you have a better score you’ll have more financing options for your business. Until then, be a diligent credit user.

Expert Q&A

Priyanka Prakash

Priyanka Prakash is a finance specialist at Fit Small Business, an educational site for entrepreneurs. A former business attorney, Prakash now helps entrepreneurs understand loan options, credit scores, cash flow management and other financial topics. She has been referenced in Credit Karma, GOBankingRates, Wise Bread, and other leading publications.

Will applying for new financing affect my credit score?

In general, yes. Every time you apply for a new business loan, the lender will do a hard credit pull, which dents your score by between one and five points. A few lenders, though, do a soft credit pull, which won’t affect your credit score.

How can I minimize further damage to my credit while financing my company?

Be selective in which loans you apply for. Don’t apply for every loan under the sun, and before you do, understand the criteria for qualifying for the loan. If it looks like you stand a good chance of qualifying for the loan, then shortlist it. I would recommend applying for no more than 2 to3 business loans if you have challenged credit.

What steps should I take when seeking a loan if I have bad credit?

  • (1) Be selective in which loans you apply for so your credit score doesn’t take a big hit.
  • (2) If time is not of the essence, take the time to improve your credit before you apply. More financing options will open up for you, and you will also save money by getting a lower interest rate.
  • (3) If time is of the essence, seek out lenders that will work with business owners who have lower credit scores. There are several alternative business lenders out there nowadays (OnDeck, Kabbage, BlueVine, etc.) who will work with lower credit business owners and won’t charge payday loan-level interest rates.
  • (4) Strengthen the rest of your loan application. Even if your credit is bad, highlight a strong business plan or strong business revenues. That will help you qualify and get a good rate.
  • (5) Concentrate on making on-time loan payments. That will prevent your credit score from decreasing even more.
  • (6) Once your credit score increases, consider refinancing.

What advice would you give to business owners who want to improve their credit score but still need to borrow money?

Small business owners with bad credit will most likely only qualify for high interest rates on a business loan. Once you get the loan, concentrate on building your credit score. Pay bills on time and reduce other credit utilization (e.g. with credit cards). Once your credit score is high enough, you may be able to refinance the loan to get a lower rate.

Are there types of financing small business owners with bad credit should watch out for? Traps they might get into with a high interest rate, etc.?

Watch out for payday loans that charge extremely high interest rates (sometimes triple digits!). Also, avoid merchant cash advances which are repaid with a portion of credit card receipts. That can really eat into a business’ profit margins.

Lastly, watch out for fees. Even if an interest rate seems reasonable, the fees can get you and end up increasing the cost of the loan. One tip is to always ask the lender what the APR (Annual Percentage Rate) of the loan is. Just to give an idea, bank loan APRs are currently around 5-8 percent and alternative business loan APRs are around 40 to 60 percent.

Is there anything else business owners should consider?

Try to plan in advance. The more time you have to look for a business loan, the less tempted you will be to fall into a high-interest payday loan or merchant cash advance.

Resources

The following are links to resources and lenders business owners with bad credit can use to learn more about their situation and where they can find financing options.

Prosper

This peer-to-peer lender is one option for entrepreneurs who have bad credit.

Fundera

This company offers competitive loans to businesses looking for funding. Compare rates and credit limits to see the best deals available.

Kabbage

Visit this website to see if you qualify for a business line of credit.

Small Business Administration

This government resource offers information to business owners on how they can check their credit and apply for business funding.

Kickstarter

This crowdfunding website is one option for business owners with a great idea who want to raise money without taking out a loan or line of credit.

Grasshopper

This blog page has information on how to increase your credit score and become eligible for more lending options.

Updated: July 28, 2017