Launching a startup is an exhilarating journey filled with ambition, innovation, and, undoubtedly, financial challenges. Whether it's a revolutionary tech solution, a unique product, or a service targeting niche markets, one crucial factor remains constant—funding.
Startups require capital to get off the ground, grow, and scale, and securing that capital can be daunting for entrepreneurs. One often overlooked aspect of this process is the impact of the founder's credit score on their ability to secure financing.
While many entrepreneurs are aware of the importance of business plans, pitch decks, and market research, only some consider the significant role that personal credit plays in funding decisions.
Lenders and investors frequently use credit scores to measure a founder's financial responsibility, and a strong credit history can substantially improve the likelihood of securing loans and investments.
Aspiring startup entrepreneurs must understand how personal credit scores affect their financing and how to improve and maintain them to enhance future financial opportunities. For example, using free credit monitoring tools dramatically improves credit awareness, leading to better strategic decisions.
The State of Startup Funding Today
Before diving into the relationship between credit scores and startup financing, it's essential to understand the current landscape of startup funding.
According to CB Insights' State of Venture 2023 report, venture funding fell to $248.4 billion—the lowest figure since 2017. Global deal volume dropped significantly by 30 percent year-on-year (Y0Y) to 29,303, indicating a six-year low. The declines prevailed across most sectors and regions around the world.
The US deal volume is also experiencing a slowdown. It's at a 10-year low. The country's venture downturn produced a chilling effect on the US tech startup ecosystem. US-based companies, used to raising record-breaking funding in the past, only raised 2,182 equity deals in Q4 of 2023. The number of deals is down 21 percent QoQ—the lowest quarterly level in a decade.
This decline underscores the increasing difficulty startups face when raising capital as venture capital firms become more selective and cautious.
In addition to the crisis, the rise in interest rates has impacted startup bank loans as lenders adopt more conservative lending practices. With fewer venture capital deals being closed and more stringent loan requirements, startup founders must find alternative ways to boost their financing prospects. One such way is by improving their credit scores.
How Personal Credit Scores Impact a Startup's Financing
A personal credit score represents an individual's creditworthiness, typically ranging from 300 to 850. Lenders, creditors, and investors often use these scores as a risk assessment tool, especially when evaluating startups with limited or no business credit history.
Here's how personal credit scores impact startup financing:
Bank loan approval
One of the most straightforward ways credit scores affect startup financing is through bank loans. Most banks require founders to provide personal guarantees for business loans, meaning the entrepreneur's personal assets back the loan. This is particularly true for new businesses without established credit or financial history.
A high personal credit score, usually pegged at above 700, signals to lenders that the founder has a track record of handling debt responsibly. This favorable metric increases the likelihood of loan approval and may result in better overall terms, such as lower interest rates, minimal penalties, or extended repayment periods. Conversely, a low or poor credit score can lead to rejection or unfavorable terms, potentially making a loan more expensive and difficult to pay.
Access to credit lines
In addition to traditional loans, many startups rely on business credit cards and lines of credit to manage cash flow. Business credit cards, in particular, are often linked to the founder’s personal credit score.
Entrepreneurs with good personal credit scores are far more likely to get a business credit card with higher limits and better rewards. This can provide valuable flexibility for covering everyday expenses or making large purchases without exhausting cash reserves.
Attracting investors
While venture capitalists and angel investors focus primarily on the business's growth potential, product-market fit, and team strength, the founder's personal credit score can still play a role. Investors may view a poor credit score as a red flag, questioning the founder's financial responsibility and their ability to manage business finances.
On the other hand, a strong credit score provides confidence that the founder can manage risk, making the startup a more attractive investment. This can be especially important in early fundraising when the business needs a proven track record.
Leasing equipment or office space
Many startups need to lease equipment or office space as they grow. Whether it's office equipment, vehicles, or heavy machinery, leasing companies often check the founder’s personal credit score before approving an agreement.
A higher credit score means better leasing terms, minimal down payments, and potentially lower interest rates, while a lower score likely results in higher costs or even rejection.
Practical Steps To Improve and Monitor Your Credit Score
Improving and maintaining an acceptable or even excellent credit score is critical for maximizing financing opportunities. Here are some practical steps for entrepreneurs:
Check your credit report regularly
The first step to effectively boosting your credit score is understanding where you currently stand. Entrepreneurs should regularly review their credit reports for inaccuracies or fraudulent activities that could drag down their scores.
Use free credit monitoring tools.
Free credit monitoring tools are invaluable resources for entrepreneurs looking to track and improve their credit scores. SoFi's free credit score monitoring tool is an excellent option. It provides users with real-time credit score updates, personalized tips for improving credit, and insights into factors affecting their score. Signing up is quick and easy, and the benefits of regularly checking your credit score cannot be overstated.
With score monitoring, entrepreneurs can better understand their credit profile and take proactive steps to check, maintain, and improve their score. This, in turn, enhances their ability to secure financing at more favorable terms.
Pay bills on time
According to FICO, payment history carries significant weight and accounts for approximately 35 percent of your total credit score, making it the most important factor determining your score. Late payments, especially those overdue for 30 days or more, can significantly negatively impact you. Entrepreneurs should prioritize paying bills on time to build a strong credit history.
Keep credit utilization low
Credit utilization or credit utilization rate refers to the amount of credit you utilize compared to your total available credit. A lower utilization rate (ideally below 30 percent) signals to lenders that you handle your credit responsibly. Entrepreneurs should aim to pay down high credit card balances and avoid maxing out credit limits.
Limit hard inquiries
Each time you apply for new credit, lenders may make a hard inquiry on your credit report, which can temporarily lower your score. Entrepreneurs should be mindful of how often they apply for credit and limit unnecessary inquiries.
Maintain a long credit history
The length of your credit history contributes significantly to your credit score. Entrepreneurs should avoid closing old credit accounts, as a more extended credit history can positively impact their score.
Diversify credit types
A mix of credit types—such as credit cards, installment loans, and retail accounts—can also boost your score. Entrepreneurs should aim to maintain a healthy balance of credit types without overextending themselves financially.
Boost Your Credit Score for Better Access to Startup Funding
For entrepreneurs, the path to securing startup financing is filled with obstacles, and a solid personal credit score can be a formidable tool for overcoming them. Whether applying for a bank loan, seeking a line of credit, or attracting investors, your credit score can directly influence your financial opportunities.
Proactively monitoring and improving your credit score and using tools like free credit score monitoring can enhance your chances of securing the VC funding needed to turn your startup dreams into reality. In a competitive and constantly shifting funding landscape, a strong credit history could be the key to unlocking better financial opportunities for your business.
