Small Business

How to Start a Small Business with Bad Credit

If you feel overwhelmed by your 9-5, have no personal life, and your bank account doesn’t even allow a picnic in your local park, you can still fantasize about starting your business, being your own boss and gradually rising above living paycheck to paycheck. However, there is a slight detail, known as your FICO score that stands between you and achieving your dream.

A score below 600 leads you to an APR that is hard to handle and below 500 it is a real struggle, but if you have the necessary motivation and you get creative about funding sources it can be achieved.

Money handling issues

Although we encourage everyone to follow their dreams and start a business, before you do this, take a moment to think about your finances. Ending up with a sub-par score means that you made some mistakes in managing personal money, you have a hard time keeping track of payments or you have insufficient funds to cover your debts.

If you don’t currently have a personal budget, don’t even think about starting a business without becoming proficient in this first. Otherwise, you could enter the vicious circle of debt and lending until you reach bankruptcy.

Start-up options

If you have put your financial troubles behind you, learned your lessons and are ready to move on, but your score doesn’t reflect that yet, you can think of funding options for your business. Keep in mind that most companies use a mix of sources, so get as much as possible from each one, always thinking about the cost of the money, i.e. the interest you pay in total.

Some of the options a new entrepreneur has include:

  1. Home equity loans- this is the riskiest option since to get a line of credit with a decent APR you need to put your house on the line.
  2. SBA 7(a)– these sources offer up to $50K, but the conditions are highly restrictive and competitive, requiring among others a personal financing source, no delinquency from debt obligations and more.
  3. Loans from friends and family- more than half of new entrepreneurs get help from friends and relatives to start or run their businesses. However, to avoid ruining personal relations, you should put a clear contract in place and give them fair compensation in the form of interest. Ask a lawyer to draft a contract.
  4. Grants and gifts- never say no to free money.
  5. Merchant cash advance- Some lenders ignore the credit score in return for a percentage of your future sales. You could get some running capital if you agree to give back a part of your revenue.
  6. Credit card and bank loans- for borrowers with small scores the APR tend to rise dramatically, ranging anywhere between 20% and 199%.
  7. Online loans- these could be either peer-to-peer loans or online banks. The good news here is that some of them are designed specifically for the individuals with poor credit scores. The bad news is that there are some predatory lenders out there.

Choosing an Online Loan

These days everything is easier online, and financial institutions are taking advantage of the new environment to cut costs and reach as many clients as possible. However, among the decent organizations, there are a couple of loan sharks. You need to spend enough time educating yourself about the warning signs of dangerous loans.

The top five items you must consider before comparing APRs and repayment time include:

  • Not asking for upfront fees.
  • Being a registered business in your state.
  • Having a secured website (http https) to ensure data privacy once you sign up.
  • Transparent about fees and operating terms, you don’t have to look for the fine print.
  • Excellent communication with the three credit bureaus to use this loan as a way to fund your business and rebuild your FICO score at the same time.

You can start off your quest by looking at the AAA Credit Guide, a place for the savvy money conscious credit shopper to get a few ideas about possible red flags when searching for a funding source. This source also offers a great selection of online options with reasonable APRs, most in the 7%-36% range, with repayment terms between 3 and 72 months.

Summing up

If you aim to start a business, it’s a good idea to create a sound business plan, complete with a budget and financing sources. Start with “free” money such as grants and gifts, move to low-interest loans like borrowing from friends and family and get the remaining money from higher interest sources like loans or credit lines. Aim to borrow as little as possible from lenders and repay it as soon as you can.

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Rehan is an entrepreneur and content strategist passionate about writing stuff for startups. His areas of interest include digital business strategy and strategic decision making.

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