Finding financing for a startup is one of the biggest challenges faced by a business owner. A recent study just released, conducted by Peter Bolin, Experian Director of Consulting and Analytics, makes a good connection between startups, young companies, and the role they play in job creation—and why lenders shouldn’t back away from financing young companies.
I recently spoke with Bolin, and here is what the data reveals about small businesses, the role they play in the U.S. economy, and what needs to happen to encourage it:
Ty Kiisel: What inspired this particular research project?
Peter Bolin: Politicians and the media like to talk about the importance of small business to our economy, and we were curious to discover what that role really was—particularly in the aftermath of the recession.
Kiisel: What did you discover?
Bolin: For starters, the data confirms that small businesses are the engine of growth in the United States. We also discovered that startups tend to boom when the economy struggles, which was taking place in the years following 2008. It was particularly fascinating to see how the growth of those companies that started in 2010 have mirrored the growth in our economy over the last four years.
Kiisel: It’s not hard to guess that small businesses would grow as the economy grows, why is this an important revelation?
Bolin: As these businesses grow, they are adding employees and contributing to the drop in unemployment. For example, those 2010 startups we’ve been talking about had an average of four employees in 2010. Since then, on average, they have added 1-1/2 employees.
Kiisel: That’s somewhere around 30% job growth isn’t it?
Bolin: That’s correct. These small businesses are creating a lot of jobs; in fact the key attribute of any startup is its ability to grow—which requires capital. Unfortunately, traditional lenders have stayed away from these companies they perceive as very risky, although many of them are highly “lendable” in our opinion.
Kiisel: What do you mean by “lendable” and what message should that send to small business lenders?
Bolin: While their credit scores will naturally be lower because their credit history is short, there are often other factors that make these business owners potentially good borrowers. We are telling our lender customers to avoid automatically dismissing this group as high risk. In our study group, an average Experian business credit score of 23 (on a scale of 1-100) the first year of business, soon improves to somewhere in the 30s, and eventually has moved into the 40s. New business might equal lower scores, but the average small business owner is creating 1-1/2 trade credit relationships each year and using smaller loans to build their credit profiles over the first few years. Ultimately indicating to us that many of these businesses are great borrowers
Kiisel: Can you describe the younger businesses that are finding the most success with lenders?
Bolin: While the businesses may be younger, they are led by more experienced and older entrepreneurs. They have a viable product and demonstrate a large potential for growth. They also have an established team and a well-defined business plan.
Kiisel: What is your advice for startup entrepreneurs?
Bolin: It’s not likely you’ll be able to go into the bank and get $100,000 for working capital. Start by establishing trade credit with your vendors. Make sure they report to the credit bureaus, like Experian, and make sure you make your payments on time. Apply for a business credit card and make sure you make those payments on time. This will dramatically increase the depth of your credit report so when you do need that $100,000 from the bank or other lender, you’ll be likely to get approved. Additionally, don’t use your personal credit for business expenses. Take the time to establish a strong business credit profile. Consider it an investment in the future of your business.
Small businesses make an important contribution to the U.S. economy, but need capital to grow, create jobs, and thrive. The Experian data not only tells the story of that impact, but also suggests some actions business owners should be taking in those first few years of business to improve their ability to access capital down the road.
Click HERE to read more about financing options for startups.