Beware of These Business Credit Traps
Posted December 30, 2015
An entrepreneur had spent $80,000 buying a corporation that he was assured came with access to $250,000 in credit lines. He got the corporation, all right, but the promised credit lines never materialized, and he had to start from scratch. Oops.
That story was shared with my friend Geri Detweiler by small business attorney Garrett Sutton, one of a handful of Robert Kiyosaki’s Rich Dad Advisors, who has helped business owners around the country (and internationally) incorporate and protect their assets.
He’s heard from a number of prospective small business owners who wasted a lot of money trying to "build business credit." They had been promised that if they followed certain steps they could secure thousands of dollars in funding for their businesses with no personal guarantee or risk, build wildly successful businesses and get rich.
We all know who gets rich in that story. And it’ not the business owner. Anytime you have individuals who need money, you’ll find individuals who see opportunity to suck that money out of them.
If you want to know more about the ins and outs of business credit, Geri and Garrett have just released a terrific new book, Finance Your Own Business: Get on the Financing Fast Track that shows business owners how to set up their business for financing success. They explain how to build business credit, and understand and take advantage of all the new options for borrowing money that seem to crop up daily. They also warn readers about some ways they may get burned.
Here are three business credit bonfires to avoid:
Buying a Shelf Corporation
The promise here is that you buy a corporation that has been in business for years and use that to jumpstart the credit building process so you can get access to lots of business credit fast. There are times it makes sense to buy a shelf corporation, but be very leery of the idea that it will automatically come with access to lots of credit. Thats a quick way to be expensively disappointed. The shelf corporation will probably have to build business credit the same way another other does. And if there is any negative credit associated with the corporation you could be stuck with it. (You can check the corporation’s credit profile and score yourself before you shell out your money. More on that in a moment.)
Raiding Retirement Funds
If you don’t have access to money from friends or family you may be tempted to tap your retirement funds to start your business. That’s risky enough, but some promoters will suggest you use something called a "Checkbook IRA." Cashing out an IRA early means taxes and penalties, and you can’t borrow against an IRA, so this approach involves setting up an LLC owned by the IRA. The LLC in turn owns real estate or the business. As Garrett Sutton explains in "Finance Your Own Business," this approach is very risky and one misstep means you can wind up with the whole scheme disqualified by the IRS, which can put you on the hook for taxes and penalties.
Business Credit Building
Here the promise is that your personal credit doesn’t matter. Even if you have bad credit, the pitch goes, you can quickly build business credit and have access to plenty of credit. But not so fast. Just like building personal credit, it takes time to build strong business credit ratings.
Building business credit isn't instant magic, it's a process that just takes some time, knowledge, and willpower to not jump at some quick business credit pitch.
It’s true the process of building strong business credit ratings can seem incredibly confusing.The process is very different than what we are used to with personal credit. (A top FICO small business score is 300!) As a result, business owners either give up or don’t get started at all, which can turn out to be a mistake when they try to get financing. Or they spend a lot of money trying to shortcut the process. There are legitimate business consultants who help business owners too busy or overwhelmed to navigate the confusing world of business financing. And there are definitely times when you may want to go that route.
If you want to build business credit and avoid scams, there are two good resources to consider. One is their new book, Finance Your Own Business; Get on the Financing Fast Track. The other is a free account with Nav. That free account will give you a free personal and business credit rating and steps to build your business credit scores. And who doesn't like a little free help to get headed in the right direction?
Frankly, starting a business is tough enough, and I should know from personal experience. It's smart to get as much knowledge and street smarts about business credit before you find yourself up a creek with a business credit score to paddle your way back home.