Real estate investors often don't think of themselves this way, but in reality every real estate investor is a 'business owner'. That's because each parcel of real estate you own has its own unique location, tenants, cash flow, maintenance costs, financing and property taxes. And yet, many investors continue to do business in their own names and use their own personal credit to acquire properties. The good news is there's a better way.
PERSONAL CREDIT v. BUSINESS CREDIT.
Real estate investors make 'the deal' with the seller, but they actually buy their properties with either institutional lender financing or seller financing, or some combination of both. When an investor makes a decision, it's the property that has to qualify, not the buyer. But when it comes to financing the deal, it's usually not that way.
In most cases, a personal guaranty is involved. Lenders collect personal financial information before making a decision about your loan. They want information such as your personal balance sheet, income statement and a personal credit profile in order to make a decision about the loan. The higher your debt to personal income ratio, the more of a strain is being put on your personal credit. Many investors step up and sign personal guarantees because they feel they have no other choice. Yet if you use personal credit too often, it can actually hurt your personal credit score.
Your personal credit profile - like it or not - is tied to your social security number and the way in which you have managed your personal finances. The files kept by the consumer credit reporting agencies are separate and distinct from those kept by a business credit reporting agency but most people don't know the difference and don't understand what a powerful impact developing a business credit profile can be - if it's done right.
THE KEY IS BUILDING A SEPARATE CREDIT PROFILE.
No matter what your personal credit score is today, it is possible to build a business credit score that is entirely separate and distinct from your own personal credit. It takes planning and focus, but it can be done. With a disciplined and systematic approach, you can work build a positive business credit score that is not tied to your personal credit and spending habits, and you can do so in a timely manner if you follow a specific approach.
STEP ONE: CREATE A BUSINESS.
Establishing your 'business entity' is the first step. For most real estate investors, the entity of choice is a Limited Liability Company ('LLC'). Today, the national trend in company formation is that more LLCs are being formed throughout the USA each year than corporations. That wasn't always the case, but today with IRS adoption of its check-the-box regulations, as well as with the asset protection and privacy now available in states like Nevada, limited liability companies have become very popular for their flexibility, privacy, protection and simplicity of operation. (See our Special Report on LLCs versus 'S' corporations).
On top of that, in the last 10 years the 'Series LLC' has emerged as the leading edge in the evolution of the LLC in America. It saves you repeated costs (upfront) in legal formation and (at the back-end) tax accounting. The Series LLC essentially acts as a 'mother ship' allowing 'cells' or 'series' to distinguish each of the business enterprises (or properties) from the others, giving each one the ability to have separate business activities, cash flow statements and accounting but still having the ability to consolidate at the end of the year. That can save you thousands by not having to do separate business tax returns. The bottom line is that the more you don't have to spend on lawsuits, taxes and financing costs, the more you have to reinvest in acquiring more real estate.
STEP TWO: HOW TO USE 'BUILDING BLOCKS' FOR SUCCESS.
The next step is to build credibility so that credit grantors as well as business credit reporting agencies will understand why your business should enjoy a favorable business credit score. Many people 'assume' that business and consumer credit bureaus are one and the same, but that is not so. Let's take a look at the major business credit bureaus before moving on into how exactly business credit should be established.
Dun & Bradstreet, Experian Business, Business Credit USA, Equifax Business,Client Checker, FD Insight together make up the vast majority of the business credit reporting transactions in America today. The 'big boy on the block' of course is Dun and Bradstreet, with approximately 70 million businesses registered. The closest competitor is Experian Business, which has about 14 million businesses registered. Each of the agencies has an army of employees that do nothing but 'verify' certain elements of the business information - and if there are any inconsistencies or questionable entries, these raise 'red flags' as to that business, which immediately result in a less favorable credit rating.
There are some ground rules to understand. First, personal credit scores and business credit scores have two distinct scales on which they are measured. Personal credit scores (which run from 300 to 850) are tied to your social security number as a personal identifier. Business credit is tied to the taxpayer identification number (EIN) of the business entity and runs from 0 to 100. On the business side, a score of 75 or better is considered excellent.
The most frequent mistake of all made by business owners seeking business credit is to register with the business credit bureaus 'too soon'. That is, they sometimes do so before they have all their 'ducks lined up' and verified by an independent third-party. They believe that by simply registering with the major business-related credit bureaus, they can start applying without being red-flagged. That is why taking specific action steps before registering with the business credit bureaus is so important. So the key of course is to have your ducks all in a row before submitting a registration to Dun & Bradstreet. The sequence must be followed meticulously so that every step expected and verified by the business credit bureaus has been pre-coached and pre-verified beforehand. Where personal credit might be 'repaired' if there have been problems in the past, there is no such equivalent in the world of business credit. So it's important to 'do it right the first time'. After all, the goal is acquire a strong business credit score in as short a time as possible, right? Looking at the big picture, the proper steps in the proper order are as follows:
o Formation of a Corporation or better yet, a Limited Liability Company
o Obtain a Employer Identification Number 'EIN'. This is obtained through the Internal Revenue Service ('IRS") and can be done online.
o File a DBA ('doing business as') form if the business is going to do business under a name that is different than the legal or company name. Normally the DBA is publicly filed in the County where the business is going to operate, and in some localities publication in a 'newspaper of general circulation' is required.
o Business License. A business license is require to operate a business in nearly all cities and most counties. A new business may also be required to obtain certain permits depending on the type of business.
o Business Registration with the Department of Taxation. Normally this is a step in order to comply with local requirements for business taxation or sales tax permits.
o Assessor's Office. Depending on your locality, the County Assessor's office may need to issue a clearance so that you are in compliance with any local assessments due to the property use.
o Zoning Ordnances. These may be applicable depending on the type of business. It's best to check with the City and not overlook this so that it doesn't pop up later and create a compliance red flag.
o Address and Phone Number. Make sure that the business address on all paperwork is the same between the state, the county, the city, and the telephone company for your directory assistance listing. The credit bureau will check to see what your directory assistance address is, and whether it is the same as the address shown on your licenses, permits, and mailing address. If it is not, that creates a 'red flag'.
o Prepare a business financial statement and include it with a properly prepared business plan that would make sense if you were loaning money to a third party.
STEP THREE: BUILDING CREDIBILITY.
The final step in building business 'trade credit' is to establish a basis for a favorable rating right up front. Instead of using your individual personal name and social security number, once your business is registered, any credit reporting should be done using the business entity name and its employer identification number ('EIN'), which is the business equivalent to the personal social security number. 'Trade credit' is often underestimated. It is actually the largest source of financial lending in the world today because of the sheer numbers used in real estate development, shipping, freight, construction, etc. Many business owners get frustrated at the seemingly slow pace at which they might garner business credit. Often the reason for the pace they are frustrated by is actually caused by them. That is, they 'start off' the wrong way - and these early mistakes in the basic set-up often cause 'red flags' to be raised by the business credit reporting agency.
After these preliminary steps are complete, your business will be ready to start working on business credit development --- but not until then. In preparing for lines of credit, you want to start proving up a payment history with companies that will report business credit in the name of your business. My advice is that it would be prudent to not register your company with any of the business credit bureaus without first considering the use of a professional coach familiar with this area.
To be honest, a certain amount of 'hand-holding' may be the fastest way to learn from the mistakes that others (ahead of you) have already made. That way, you won't repeat them and you won't waste time brushing off your scraped business knee to start over again. This is where there is no substitute for experience and expertise. That's why working with an experienced business credit coach might be the smartest way to go if you want to do this quickly and efficiently and to achieve the kind of high business credit score you're going to want if you are serious about building wealth through your real estate business enterprise.
I often get requests at workshops and conferences where I speak around the country for more information and referrals to quality providers. If you'd like to get started, send me an e-mail and I will show how to start down that path with reputable and ethical coaching to 'do it right the first time.'
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