Introduction
In today’s business landscape, it’s not just your company’s balance sheet or your innovative product that interests potential lenders and investors. There’s a personal element that plays a crucial role in your business’s financial future – your personal credit history.
Personal credit history is a record of an individual’s past borrowing and repaying behaviour, including the timely payment of loans and the status of credit account balances. It can significantly influence your business’s ability to secure commercial capital, which can include bank loans, lines of credit, or even investment from venture capitalists.
Every business owner’s goal is to grow and expand their business, and access to commercial capital is often a vital component of this process. Commercial capital can fund new projects, smooth out cash flow, and provide the financial stability that allows businesses to take strategic risks. However, gaining access to this capital often depends on the personal credit history of the business owner, especially for small businesses and startups.
Lenders and investors may scrutinize the business owner’s personal credit history because it’s seen as a measure of the owner’s reliability and financial acumen. A strong personal credit history can signal to lenders that the business owner is likely to repay their business loans promptly, reducing the risk to the lender. On the other hand, a poor personal credit history can create a barrier to securing commercial capital, as it might suggest a higher risk of default.
As we delve into the importance of personal credit history and its impact on access to commercial capital, we will explore how to understand your credit history, ways to improve it, and alternative sources of capital that might be available. The aim is to equip you, the entrepreneur, with knowledge and strategies to successfully navigate your business’s financial journey.
Understanding Personal Credit History
Personal credit history is a comprehensive record of your credit-related activities. It includes details about credit accounts you’ve opened (such as credit cards, mortgages, and car loans), how much you owe on these accounts, your payment history, and whether you’ve ever defaulted on a loan. These details are compiled and maintained by organizations known as credit bureaus.
What Constitutes Personal Credit History
Personal credit history consists of several components:
- Payment History: This is a record of whether you’ve made your credit payments on time. Late or missed payments can negatively impact your credit history.
- Credit Utilization: This is the ratio of your outstanding credit balances to your overall credit limits. Lower utilization rates can positively impact your credit history.
- Length of Credit History: The duration of your credit accounts being open also plays a part. Longer histories can demonstrate more experience managing credit.
- Credit Mix: Having a variety of credit types (credit cards, mortgage, car loan, etc.) can demonstrate your ability to manage different forms of credit.
- New Credit: If you’ve recently opened several new credit accounts, it could signal higher risk to lenders.
The Role of Credit Bureaus in Canada
In Canada, there are two major credit bureaus: Equifax and TransUnion. These bureaus collect information from various sources, including lenders, creditors, and public records, to compile credit reports for individuals. They also provide credit reports to lenders, insurers, landlords, and other businesses upon request, typically when you apply for a loan or a line of credit.
Understanding Credit Scores and Credit Ratings
A credit score is a numerical representation of the information in your credit report. It’s a tool lenders use to quickly assess your creditworthiness. In Canada, credit scores range from 300 to 900, with a higher score indicating a lower credit risk.
Your credit rating, on the other hand, is a letter grade assigned to each of your credit accounts, reflecting your payment history. For example, a rating of “I1” on an installment account means it’s in good standing with payments made on time, while “R5” on a revolving account like a credit card indicates that the account is at least 120 days overdue.
Understanding these factors will allow you to take control of your personal credit history, and ultimately enhance your ability to access commercial capital for your business.
How Personal Credit History Affects Access to Commercial Capital
A healthy personal credit history can significantly impact your ability to secure commercial capital. It often acts as a reflection of your financial responsibility, influencing lenders’ decisions when considering your loan application.
The Role of Personal Credit History in Commercial Loan Decisions
Commercial lenders use personal credit history as one of the key deciding factors for loan approvals. It provides lenders with a sense of your past behaviour regarding debt repayment and overall financial management. A strong personal credit history can suggest that you’re likely to repay the loan on time, reducing the risk for the lender. Conversely, a poor credit history can indicate a higher risk, making lenders more hesitant to offer funding.
Why Lenders Look at Personal Credit History for Business Loans
Especially for small businesses and start-ups, lenders often consider the owner’s personal credit history because the business itself might not have had the opportunity to establish a robust credit history. The assumption is that business owners who manage their personal finances well will also be responsible with their business finances.
In some cases, lenders might require a personal guarantee for the loan. This means that if the business is unable to repay the debt, the owner becomes personally liable. In these situations, the owner’s personal credit history becomes even more crucial.
The Disproportionate Impact on Black Entrepreneurs
Studies and Statistics Demonstrating the Disparity in Access to Commercial Capital for Black Entrepreneurs
Research has shown a racial disparity in access to commercial capital for Black entrepreneurs in Canada. In a 2022 DBPA survey of over 1,500 Black-owned businesses, 87% said that accessing finance in Canada is too difficult for Black businesses.
And although the average Black business owner has an almost identical credit score (678) as the average Canadian (680), 63% of Black business owners indicated that they had challenges accessing finance to scale their business.
Survey of Black Business Owners
Source: DBPA Survey 2022
Effects of Systemic Biases and Historical Financial Exclusion
The disparities in access to capital are in part attributable to systemic biases and historical financial exclusion. The personal credit history of Black entrepreneurs can be negatively impacted by systemic issues such as income inequality and lack of access to financial education and resources, which are deeply rooted in historical and systemic racism.
These systemic biases extend into the financial sector, where Black entrepreneurs face bias, both explicit and implicit, when seeking commercial capital. This can result in unfavourable loan terms or outright loan denial, creating significant obstacles for Black entrepreneurs looking to start or grow their businesses.
In addition, the historical financial exclusion of Black communities has resulted in fewer opportunities to build strong credit histories. This can have a lasting impact, making it more difficult for Black entrepreneurs to access commercial capital and perpetuating the cycle of financial inequality.
Addressing these disparities is a complex issue that requires concerted efforts from financial institutions, policy-makers, and community organizations. These efforts should include implementing fair lending practices, promoting financial education, and providing resources and support to Black entrepreneurs.
Strategies to Improve Personal Credit History
Best Practices for Maintaining and Improving Personal Credit Score
Your personal credit score is a reflection of your financial responsibility and is critical when seeking commercial capital. Therefore, maintaining and improving your score should be a top priority. Here are a few best practices:
Make timely payments: The most effective way to improve your credit score is to consistently make payments on time. This includes credit cards, loans, and bills. Late or missed payments can significantly affect your credit score.
Keep your credit utilization low: Credit utilization is the percentage of your total credit limit that you’re using. It’s recommended to keep this below 30% to avoid negatively impacting your credit score.
Diversify your credit: Having a mix of credit, such as credit cards, car loans, and a mortgage, can positively impact your credit score.
Advice on Correcting Errors in Credit Reports
Errors in credit reports can lead to a lower credit score. Therefore, it’s important to regularly check your credit reports from the two major credit bureaus in Canada, Equifax and TransUnion. If you spot any inaccuracies, you should report them immediately. The bureaus are obligated to investigate any disputes and correct errors.
The Importance of Managing Personal Finances and Debt
Managing your personal finances and keeping debt under control is crucial for maintaining a good credit score. Here are some strategies:
Create a budget: A well-structured budget can help you control your spending and ensure you have enough money to cover your bills and save.
Pay off debt: Aim to pay off outstanding debts as quickly as possible. Prioritize high-interest debts, as they cost you the most over time.
Avoid unnecessary debt: Before taking on new debt, consider whether it’s necessary and if you can afford the repayments. Unnecessary debt can lead to higher credit utilization and more difficulty making timely payments.
Remember, improving your credit history is a marathon, not a sprint. It requires consistent effort over time. But the payoff—increased access to commercial capital for your business—is well worth the effort.
