Having a business partner can be great when you have complementary skill sets or want to bounce ideas off each other, but a partner can also hurt your ability to get a business loan if he or she has a low credit score or low income level. In this article, we explain how a business partner can either hurt you when you’re on the market for business financing and how to remedy this situation.
“The 20 Percent Rule”
When you apply for a business loan, most lenders will want to check the credit history and income level of every person who owns 20 percent or more of the business. It doesn’t matter who actually fills out the loan paperwork and signs the loan agreement. For this reason, assuming your partner owns at least 20 percent of the business, his or her bad credit or low income level could spell trouble for you in your search for financing.
When a lender says they require a credit score of at least 600, they will apply this requirement to every individual who owns at least 20 percent of the business. So even if your own credit score is great, there’s no guarantee you’ll be approved if your business partner’s credit score isn’t so great.
The same goes for income. If a lender requires a debt-to-income ratio of less than 40 percent, that applies across the board for all business owners who own 20 percent or more of the business (debt-to-income ratio measures how much debt you can service by dividing your annual debt and interest payments by your annual business and personal income).
What Can You Do?
If your business partner’s credit score or income are hurting your chances of qualifying for a loan, there are several steps you can take to address the situation:
- Improve personal credit. The easiest way to increase the chances of qualifying for business financing is of course for the business partner with poor credit to improve it. There are several simple steps you can take to build personal credit, starting with paying bills on time, paying down high-interest-rate debt, and reducing credit utilization. In addition to these steps, disputing errors on your credit report is a simple way to boost your credit score. You can do this alone or seek out a credit repair service for assistance.
- Build up business credit. Building up a business credit score independent from the individual scores of you and your business partner can help the business qualify for financing on its own terms. A business with a good commercial credit score is less tied to the credit scores of its owners. You can build business credit by paying suppliers on time, opening and using a business checking account, and opening and using a business credit card.
- Transfer ownership of the business to the owner with better credit or higher income. You can transfer ownership of the business to the higher credit or higher income business partner to eliminate the bad credit from consideration. Doing this isn’t too difficult from an accounting and financial standpoint if the partners have a buyout agreement in place, and one partner can afford to buyout the other’s ownership share. If your partnership agreement doesn’t make the terms for buyout clear, we recommend that you use the assistance of an attorney and accountant.
- Obtain a co-signer. Last but not least, you can bring on a co-signer for your business loan. In most cases, a co-signer must be a blood relative of a primary business owner or somehow affiliated with the business. A co-signer with strong credit and income can strengthen your application because often times, lenders will take the average of business owners’ and guarantors’ credit scores and incomes. For instance, suppose you have a FICO score of 550, your business partner’s score is 500, and you bring on a co-signer with a 750 FICO score. Taking the average of these scores, many lenders would view you as a borrower with a credit score of approximately 617.
Even if you’re the one applying for a business loan, your business partner’s credit score and income can help or hurt you in qualifying. If your business partner has a low credit score or income, follow our advice above to minimize the impact and increase your chances of qualifying for business financing.