How to buy a business with bad credit

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    Michael David

    Page written by Michael David. Last reviewed on May 13, 2024. Next review due October 1, 2025.

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      Don’t let bad credit stand in the way of a great business. You may have to clear a few extra hurdles in order to secure the financing you need, but it can still be done. Here’s some information to help make it happen.

      Let’s start with the good news. Your credit score is only one of five criteria that financial institutions traditionally assess when considering a business loan application. So, even if you have bad credit, you still have an opportunity to show a potential business loan provider your other strengths.

      Here are the five Cs of business loan credit:

      • Character: How credible and trustworthy are you? While your credit score is part of the answer here, there is also your education, your work history, your entrepreneurial experience, and your notable accomplishments. 
      • Capital: How much capital (money) are you investing in the project? The more capital you contribute as a percentage of the overall project, the more committed you will be, and the less risk you are asking the lender to take on.
      • Capacity: How much debt will you be carrying? Your debt-to-income (DTI) ratio looks at how much you make versus how much you are paying towards debt on a regular basis. Your capacity to borrow is generally limited by a maximum acceptable DTI.
      • Collateral: Is there a home or other asset that the lender can seize if you fail to repay? Having collateral to pledge can greatly reduce the risk to the lender. This makes it easier to borrow and may reduce your interest rate as well.
      • Conditions: How much do you need, how soon will you pay it off, and at what interest rate? All of these variables can be part of the conditions of your business loan. If you have bad credit, you might expect more stringent conditions. 

      If you want a business loan but have bad credit, there are several ways to work around it. If you have other things going for you, like a great professional track record, a winning business idea, capital of your own to contribute, and/or an asset to pledge as collateral, you might very well be offered the loan you need, albeit with an extra condition or two, compared to someone with perfect credit.

      What is bad credit?

      Banks and other lenders use a scoring system to rank the creditworthiness of borrowers. From their point of view, your credit score is an indication of how risky it will be to lend you money. The higher your score, the better your chances of getting approved for a business loan or other forms of credit.

      Here’s how the scoring system stacks up:

      300-559 – Bad credit

      560-659 – Fair credit

      660-724 – Good credit

      725-759 – Very good credit

      760-900 – Excellent credit

      You can increase your credit score by making credit card and loan payments on time and by carrying less debt overall.

      How does bad credit affect business financing?

      A bad credit score can make obtaining a business loan more difficult. You may need to expend more time and effort convincing a traditional lender to give you the credit you seek. You may be able to do this by emphasizing the stronger aspects of your application beyond your credit score. You may also need to investigate non-traditional funding sources, such as alternative lenders, working with a credit partner, or arranging vendor-take-back financing.

      Another way bad credit can affect your business financing is the cost of borrowing. A bank will likely charge a higher interest rate if you have a low credit score compared to someone with excellent credit. Alternative lending arrangements outside of a traditional bank also tend to come with higher interest rates.

      Steps to buying a business with bad credit:

      If you have bad credit, it is best to be open and honest about it with lenders. You cannot hide the truth, and trying will only damage your character (the first of the 5 Cs of credit). 

      It’s preferable to provide the lender with context that will help your case. What were the circumstances that lead to you having bad credit? Was it the result of an unforeseen event or a past mistake? What have you learned from this experience, and what steps are you taking to rebuild your credit?

      In addition to addressing your bad credit score head-on, you can also build a strategy to maximize your standing regarding the other 4 Cs of credit: capital, capacity, collateral, and conditions.

      Beyond the 5 Cs, here are three more steps you can take to buy a business with bad credit:

      Improve your financial situation

      The first thing you might want to do is contact a credit bureau to find out your credit score. One reason to do this is so you know your starting point and what you might be up against. A second reason is so that you can identify any potential errors. For example, if you find an outstanding balance listed that you know you have paid off, you can contact the bureau to have it fixed and potentially make an instant improvement to your credit score.

      Here are a few more tips that can help your score:

      • Pay your bills on time. All it takes is one payment 30 days past due to put a negative mark on your score.
      • Pay off your credit card every month. Carrying a balance costs a fortune in interest and negatively impacts your score. 
      • Stay well under your credit limit. One of the factors in your credit score is your utilization rate. Using 30% or less of your available credit looks good, but maxing out your credit will hurt your score.
      • Be strategic about credit applications. Prepare before applying to ensure your application will be approved. Frequent credit applications will send up a red flag to hurt your score.

      Work with the right people

      If you have bad credit, choosing to work with a business partner can help with all 5 Cs of credit. The ideal partner could be someone with a high credit score, a history of business success and sound financial management, the ability to invest their own capital and/or the capacity to help carry the business loan.

      If you decide to enter a partnership, you will also want to work with a lawyer to help you draft a partnership agreement. This agreement covers things like roles and responsibilities while acquiring and running the business, and equally crucially, what will happen if the partnership comes to an end someday. 

      Secure a guarantor

      Another option for buying a business with bad credit is to have someone guarantee or co-sign your business loan. If you have a friend or family member with the credit score, assets, and income the lender is looking for, they can agree to take responsibility of repaying the loan if you fail to do so.

      This is a major commitment for the co-signer. Their guarantee will appear on their credit history and may limit their future ability to borrow money for their own purposes. And, of course, if you cannot repay your business loan for any reason, the responsibility will fall to them.

      On the flip side, you might know someone who wishes to take on this risk in exchange for a percentage of ownership in your business. This person may even wish to be an active participant in the business with a vested interest in your success.

      Avoid further damage to your credit by being proactive:

      When it comes to business financing, it is better to be proactive than reactive. You don’t want to apply for credit when you’ve already used up your savings and are starting to miss payments. Instead, you want to anticipate your need for credit so you have time to prepare, then apply from a position of strength and get the funding you need with time to spare.

      Read on for some ways to be proactive: 

      Plan your project ahead of time

      If you have a bad credit score and want to buy a business, planning and preparation are going to be key. Here are some things to work on before you talk with potential lenders:

      Have a good business plan. Be prepared to show in detail why your product or service is in demand, who your customers are, how you will acquire them, and how you will sell to them profitably. 

      Show how you will repay. Gather supporting documents, such as contracts and purchase orders that demonstrate your ability to repay. If the business is a startup and there is no history to draw upon, produce detailed and realistic forecasts that demonstrate how you will repay the loan.

      Be prepared for the 5Cs. Prepare answers as to why you have the character and credibility to be creditworthy. Document the capital you are putting at risk in the business and the income you have to carry the loan. Highlight any partnerships, potential guarantors, or other relationships that bolster your case.

      Preparing this way will not only speed up the application process, but it will also speak volumes to the lender about your level of commitment and responsibility.

      Consolidate current debts

      If you currently have a number of different loans, credit cards, or other debts, a debt consolidation loan might be worth considering. By borrowing a single large sum to pay off you other debts, you can potentially lower your monthly payment, simplify your finances and help improve your credit score over time. But beware: this strategy is only beneficial as long as you don’t run up those old debts again — it takes discipline.

      Get started with Swoop

      Whether your credit is poor, excellent, or somewhere in between, let Swoop scan the market for the best business financing options and deliver them to you in minutes. You can get started right now

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      Written by

      Michael David

      Michael David is a financial writer and former investment advisor. Writing for Capital Group, Dimensional Fund Advisors, Franklin Templeton Investments, HSBC, Invesco, PIMCO, Vanguard, global insurance companies, major banks and others, he has educated professionals, business owners and consumers about strategies for investing, insurance, banking and corporate finance for more than 20 years.

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