You don’t want to be turned down if you ever need a loan, so avoid these common errors.
Starting and running a small business is difficult enough without reading stacks of legal documents or worrying about hiring a lawyer. So most small business owners, especially mom and pop shops and solopreneurs, follow the simplest path, setting themselves up with a DBA, a tax ID number, and a post office box.
That approach can lead to big problems, according to S.E. Day, host of the Legally Steal TV and radio show in Tampa. If you go that route, you may regret it when you try to secure a business loan, or find yourself personally liable for an injury related to the business, he warns. That kind of mistake can kill an otherwise viable company and the sad thing is, most small business owners take this approach have no idea they might be headed for trouble.
If you want a legally solid, financially secure, and credit-worthy business, Day says, be careful to avoid these common pitfalls:
1. Not bothering to incorporate.
Incorporating isn’t as tough as many people think–it’s usually a simple matter of filing an application with whatever state you’re in. And if it’s slightly more trouble than getting a DBA, that extra effort is more than worth it, Day says. Imagine you start a home-based business baking cookies. The cookies are a hit, and soon you’re shipping them out on a daily basis. One day a delivery person picking up an order trips over the sprinkler system and breaks a leg. “You can be liable,” Day says. “You didn’t separate yourself from your business. You may think your homeowners insurance will protect you, but if you didn’t tell the insurance company that you have a business there, that won’t do it. They can sue your insurance company and you.”
On the other hand, he says, “Once your company becomes an independent entity it can live beyond you. That protects you from those sorts of lawsuits.”
2. Using a P.O. Box.
It seems so logical. A post office box number makes you look more official than an address with an apartment number. And if goods or payments come to you in the mail, it’s more secure as well. But using a post office box as your address can make it harder to secure a business loan.
“Corporate creditors want accountability,” Day explains. “If you have a P.O. box, they can’t account for you. They can’t drive by your business.” To make matters worse, there’s a popular bit of fraud where someone opens a business using a post office box, then sets up corporate accounts with several carriers, ordering 20 mobile phones from each for the supposed employees. The carriers issue the phones–at two-year contract pricing–and the thieves take them overseas and sell them at enormous profit. By the time the first month’s payment is due on that cell phone service, the business has vanished.
3. Not getting a Dun & Bradstreet number.
Dun & Bradstreet’s D-U-N-S number allows prospective creditors to view your business credit report, just as they do for individual borrowers. You get the number by registering your company at the D&B website, and it’s either inexpensive or free, depending on how quickly you need it.
“D&B is the oldest and most prominent collect of business data in the United States,” Day says. “If you go to the bank for a loan and the bank doesn’t know you, the first thing they’ll do is look for your D-U-N-S number. Having it confers legitimacy.”
4. Paying bills right on time.
You have 60 days credit terms on your account. Why should you pay a month early? It will help you a lot if you ever apply for a business loan, Day says. Companies have credit scores just as people do, although their scoring system goes from 1 to 100 instead of 800. As you may know, the formula for determining an individual’s credit score is fairly complex, and involves multiple factors such as how much debt you already have, your borrowing and repayment history, and many others.
By comparison, the formula for business creditworthiness is much simpler: It depends solely on whether you have a history of paying bills on time and in accordance with credit terms. Given that knowledge, you can drive up your score by making it a habit to pay invoices ahead of time, Day says. “If you pay bills when they’re due, you’ll get a credit score of 75 to 80. If you pay them five days early, you’ll get 80 to 85. If you pay them 30 days early you could get a score of 100. It’s as simple as that.”
5. Minimizing your income for tax purposes.
It seems logical enough: When it comes time to file your business taxes, you look for every deduction you can find to offset your business revenues and lower the resulting tax bite. This might seem like a good strategy but it can be short-sighted.
“If you’re showing a net operating loss, banks won’t be willing to give you credit,” Day says. “You need to show a profit when you file your taxes and not hide everything.”
6. Neglecting your personal credit rating.
What does your credit rating as an individual have to do with the creditworthiness of your business? Everything, since October 2001 when Congress passed the Patriot Act in response to 9/11. “Now if you go to the bank to apply for a business loan, they don’t just want your business information, they want your personal information too,” Day says. “So if your business credit is strong but your personal credit is weak, that’s going to hurt you.”
In essence, he says, “You become the guarantor for your business.” And of course, that’s exactly what most small business owners are.
More from Inc.com:
- 5 Degrees With High Earning Potential
- 5 Brand Disasters That Will Happen in 2015
- How to Avoid the 6 Biggest Financial Mistakes Young Entrepreneurs Make
- Charlize Theron Shows Why Employees’ Salaries Should Be Transparent
- 5 Things That Millionaires Do Consistently
