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When people are starting a business, it’s likely that they’ll consider the tax benefits of different company structures. In some cases, founders may create a limited liability company (LLC) specifically for its tax benefits.

Here, we’ll delve into the tax benefits of LLCs for business owners, as well as other pros and cons.

💡 Recommended: How To Incorporate

What Is an LLC?

An LLC is a type of business structure available in the United States. A kind of hybrid, it combines some characteristics of corporations with others from a partnership or sole proprietorship.

According to the IRS, LLC owners are called “members.” Depending on the state in which you set up the LLC, members may be individual people, other LLCs, or corporations. There is no maximum number of members that a company can have, and most states allow LLCs with just one member. Check your state for specifics.

Tax Benefits of Forming an LLC

As mentioned above, company founders may choose an LLC structure especially for its tax benefits. Here, we go into detail about what those benefits are.

Limited Liability

An LLC, as its full name implies, provides limited liability to its members. This means that, if the company fails, the owners’ and investors’ private assets are not at risk and can’t be seized to repay company debts.

Flexible Membership

As noted previously, an LLC can have one member or many, and those members can be individuals or companies. This business structure gives owners significant freedom when starting their company.

Management Structure Options

LLCs can be managed by a member (owner) or by a hired manager. A member-managed LLC may be chosen if the company has limited resources or few members. An owner may select a member with management experience to oversee the business, or they may want all members to actively participate in the company’s operations.

A hired manager is someone who is not a member but has the appropriate experience and skill sets to run the LLC. An accountant or financial advisor can go into detail about the tax benefits of member-manager vs. hired manager approaches. (Here’s what to know if you’re filing taxes for the first time.)

Pass-Through Taxation

LLC member-owners have some control over how their business will be taxed. If there is only one member, it will automatically be treated like a sole proprietorship, and if there is more than one, like a partnership. In those cases, business income will pass through the business to the member-owners, and they’ll only get taxed once. Members will report income and losses on their personal tax returns, while the LLC itself is not taxed. (Learn how business income differs from other types of income.)

Because income and losses are reported as part of members’ personal financial pictures at tax time, taxes will be owed at each member’s personal tax rate.

Alternatively, the LLC owners may decide to be taxed as a corporation. If they choose an S-Corp structure, pass-through taxation still applies.

Recommended: How Long Does It Take Taxes to Come Back?

Heightened Credibility

When someone opens an LLC, it shows that they’ve gone beyond just hanging a shingle. Instead, they went through the decision making and paper filing processes involved in setting up the LLC.

Limited Compliance Requirements

According to the U.S. Small Business Association (SBA), another form of business structure — the corporation — has the strictest requirements. In contrast, LLCs have some but fewer.

In general, an LLC should maintain a current operating agreement, hold annual meetings, ensure that they have appropriate shares recorded for each member, and keep records if membership interests transfer. (Find out if you can use a personal checking account for your business.)

Recommended: How To Form an LLC in Georgia

Disadvantages of Creating an LLC

So far, the LLC sounds like the ideal low-maintenance company structure. However, there are several caveats to be aware of.

Cost

Forming an LLC can cost a few hundred dollars, which may be more than what a small business wants to spend. (An online budget planner can help business owners set budgets and track spending.) The company will also need to file annual reports along with annual fees and taxes. These taxes and fees may cost a miniscule amount or several hundred dollars annually.

No Stock Ownership

When a corporation wants to raise funds, they sometimes issue shares of stock. An LLC cannot issue stock.

Recommended: How to Start Investing in Stocks

Transferable Ownership

Some states may require that an LLC be dissolved if there is a change in ownership. If the people starting the business expect to take in outside investors over the years, a corporation might be a better choice.

How to Form an LLC

Once you’ve decided to start an LLC, you’ll want to choose and reserve a company name that doesn’t conflict with currently existing ones. Typically, an LLC must have what’s called a registered agent — someone who will handle official documents for the company.

Then, you’ll need to document the nuts and bolts of the operating agreement that describes the structure of the company. This can include who owns what portion of the company and who gets to vote on which issues. You’ll detail how profits and losses will be addressed, how the company will be managed, when meetings will be held, and how to handle the business if a member leaves the company or dies. This document should also describe what should happen if the company goes out of business.

How LLCs Are Different From Other Business Entities

An LLC is formed to be a legal entity that’s separate from its owners and is responsible for its business debts. Here’s how an LLC differs from other company structures.

LLC vs Sole Proprietorship

Profits in an LLC are only taxed once because of the pass-through taxation structure. This is reported on and addressed through owners’ personal tax returns by filing a Form 1040, Schedule C, listing profits or losses. As an LLC owner, you may be taxed as a sole proprietor, a partnership, or a corporation.

A sole proprietorship is owned by one person and is the simplest structure available. A sole proprietorship also involves pass-through taxation with the business owner paying taxes on the business’s profit. There isn’t as much flexibility in filing as a sole proprietor as there is with an LLC.

LLC vs S-Corp

An LLC is a business structure. An S-corp, meanwhile, is a tax classification. Many businesses decide to have their LLC taxed as an S-corp. The nuances can be complicated, so it makes sense to consult your personal accountant or other professional before making this decision.

LLC for Rental Property

If you create an LLC to buy rental homes, you’ll have the benefits of no personal liability and pass-through taxation. There can be a flexible ownership structure, personal anonymity, and fairly simple reporting.

However, it may be harder to finance rental property as an LLC. There can also be significant fees to get the LLC up and running. LLCs for rentals can be more complex at tax time, and property transfers can also be more complicated.

Recommended: What Is a Professional Limited Liability Company?

How to Choose the Right Business Type

Consider how simple or complex your proposed business will become. Do you plan to basically run the business yourself, or will it ideally turn into something bigger? What kind of legal protections will you need based on your business plans?

Entrepreneurs should also weigh the tax benefits of LLCs and sole proprietorships. The two structures, along with partnerships and S-corps, feature pass-through benefits, meaning that profits are taxed only when they’re paid to the company owner(s). A C-corp, meanwhile, is taxed as a company as well as when shareholder payouts are made.

Consult your accountant or financial advisor for specifics on your situation.

No matter what business structure you choose, it’s important to keep track of your finances. SoFi’s spending app provides you with an easy-to-use online budget planner so you can stay on top of your finances.

The Takeaway

Limited liability companies (LLCs) come with plenty of advantages and a few disadvantages. As its name implies, the owners’ and investors’ private assets are not at risk if the company should struggle financially. Owners of the LLC are referred to as members. Membership may range from one individual to multiple individuals to other companies.

A major benefit is pass-through taxation, where income passes through the company to its members, who report it on their personal taxes. One disadvantage of LLCs for very small businesses is the startup cost and annual fees, which can run to several hundred dollars a year. Consult a professional to find out whether an LLC is the right fit for your business plan.

Take control of your finances with SoFi. With our financial insights and credit score monitoring tools, you can view all of your accounts in one convenient dashboard. From there, you can see your various balances, spending breakdowns, and credit score. Plus you can easily set up budgets and discover valuable financial insights — all at no cost.

FAQ

What are the tax benefits of having an LLC?

With an LLC, you’ll have flexibility in deciding the structure under which your company will be taxed. There are more tax benefits of an LLC, including pass-through taxation, which means you’ll only get taxed once at your individual tax rate.

What are the benefits of a limited liability company?

They can include limited liability, meaning that owners aren’t personally responsible for company debts; flexible structures; pass-through taxation; more credibility; and fewer compliance requirements compared to a corporation.

What is the best tax option for an LLC?

Each situation is unique, so consult your accountant or financial advisor for specifics.

Photo credit: iStock/hh5800

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SORL-Q424-006

If you feel like your company’s growth has stagnated, it may be time to look at inorganic growth strategies. Inorganic growth involves expanding through mergers and acquisitions rather than increasing your company’s current activities. It’s generally considered faster than organic growth but requires a larger upfront investment and comes with some risk.

Read on for a closer look at inorganic growth, including its pros and cons, how it compares to organic growth, and strategies for achieving (and funding) inorganic growth.

What Is Inorganic Growth?

Inorganic business growth is growth that is created using resources outside of the company. It typically involves mergers and acquisitions, joint ventures, or adding locations. This is in contrast to organic growth, which occurs through harnessing a company’s existing resources.

While organic growth tends to be slow and gradual, inorganic growth enables a company to expand rapidly by entering a new market that may be related to or different from its original business line. Inorganic growth typically involves a more dramatic shift in how a business operates. It also requires a larger upfront investment than organic growth. Owners will often use small business loans to fund inorganic growth.

Example of Inorganic Growth

An example of inorganic business growth is Facebook’s acquisition of Instagram in 2012. Rather than building a similar platform from scratch, Facebook purchased Instagram for $1 billion to expand its presence in the social media and photo-sharing space.

This acquisition allowed Facebook to tap into Instagram’s growing user base and capitalize on its unique features. The move provided immediate access to Instagram’s established brand and audience, fueling Facebook’s growth in new demographics.

This strategic inorganic growth decision helped Facebook maintain its dominance in the social media industry while reducing competition and diversifying its service offerings.

Recommended: IPO vs Acquisition: Advantages and Disadvantages

What Is Balanced Growth?

Balanced business growth refers to the strategy of achieving a steady and sustainable expansion by integrating both organic and inorganic methods. It involves growing through internal efforts, like improving sales, launching new products, and enhancing operational efficiency, while also leveraging external growth opportunities, such as mergers, acquisitions, or partnerships.

The goal is to balance short-term gains from inorganic growth with the long-term stability of organic development. This approach helps businesses minimize risks, maintain operational control, and ensure that growth is sustainable, scalable, and aligned with the company’s strategic objectives over time.

Inorganic Growth vs Organic Growth

Both inorganic and organic growth serve the same purpose — taking your business to the next level. But each takes a very different path to get there.

Inorganic growth involves using resources outside of the company, such as engaging in mergers and acquisitions. Organic growth, on the other hand, uses inside opportunities — such as cost-cutting measures, internal research and development, and operational improvements — to spur growth.

Another key difference is that inorganic growth typically requires a large initial investment, whereas organic growth generally involves gradually investing in marketing, human resources, and operations over time. As a result, inorganic growth usually requires taking out a business loan, whereas organic growth may or may not require financing.

Inorganic vs. organic growth also comes down to speed. Inorganic growth generally leads to a much faster increase in revenues and profits than organic growth.

Pros and Cons of Inorganic Growth

To help you decide if an inorganic growth strategy is the right fit for you, here’s a look at some of the benefits and drawbacks of inorganic growth.

Pros

Unlike organic growth, which can take time, inorganic growth results in rapid expansion, since the company you are acquiring or partnering with already has established systems, customers, and revenues.

Growing through mergers and acquisitions also gives your business access to valuable resources and assets, such as technology, intellectual property, equipment, and staff. In addition, it can expand your market share and reduce competition. Becoming a larger company can also make it easier to access capital through business loans when you need it.

Recommended: 10 Business Growth Strategies

Cons

Inorganic growth generally requires a large upfront investment, which may involve taking on debt. If your company is currently small, getting the financing you need might require collateral, which can put personal or business assets at risk.

Acquiring a new business or adding a new location can also result in management challenges. In the case of a merger or acquisition, you may end up with multiple people in the same roles and need to consolidate. Merging with another company can also lead to friction.

While inorganic growth can result in rapid growth, success is not guaranteed. Investing in another business or location can be risky.

5 Inorganic Growth Strategies

There are several inorganic growth business strategies to consider, depending on how your business is set up and how willing you are to give up your company’s independence.

1. Acquisition

Purchasing an already-established business is one way to instantly increase your business’s revenues and profits. An acquisition allows you to take over a proven business model with customers and systems already in place rather than having to build it from scratch.

Recommended: Top Business Acquisition Loans

2. Merger

In a merger, two firms agree to become partners in a larger business. To achieve inorganic growth through a merger, you might join forces with a competitor. This takes your competition out of the marketplace and allows you to absorb its market share. It also gives you access to its technology, products, and workforce.

3. New Location

Opening a new location for your existing business leverages the hard work you’ve already put into your brand. You won’t have to develop new management or marketing strategies, other than extending what you’re already doing at your original location. If you sell products, you may be able to negotiate a lower per-unit cost if you need to increase the size of your orders from suppliers to outfit a new location.

4. Strategic Alliance

When two brands see benefits in working together but don’t want to give up their individual independence by merging, you have a strategic alliance. Perhaps Company A has the audience that the other wants to reach, while Company B has technology that Company A can leverage.

5. Joint Venture

Similar to a strategic alliance, a joint venture involves two or more companies coming together to take on a particular business activity for a limited period of time. A joint venture creates a new business entity that is separate from the participating businesses. This allows the participating businesses to grow while maintaining their independence and individual brands.

Recommended: How to Grow a Business

Funding Inorganic Growth

Here’s a look at some ways your business may be able come up with the capital it needs to fund inorganic growth.

Business Loans

There are many different types of small business loans, including business acquisition loans. If you have good credit, you may qualify for a bank loan with low interest rates and favorable terms. If your business is new or you have fair credit, you may be able to get financing for inorganic growth through an online lender. These alternative lenders often have more flexible qualification criteria than banks, and also provide faster funding. However, loan amounts may be smaller and interest rates can be higher.

Equity Fundraising

Another option for funding inorganic growth is to bring on private equity investors. These individuals (or firms) can provide capital for you to acquire, merge with, or partner with another business, in exchange for equity in the company. Keep in mind, though, that investors may want a say in strategic decisions.

Invoice Financing

If you are looking for a smaller amount of financing to help fund a joint venture or strategic alliance, you might consider invoice financing. This allows you to leverage the value of unpaid invoices to get access to cash quickly. With invoice financing, lenders advance a percentage of your unpaid invoice amount (often as much as 90%). When your customer pays the invoice, you repay the lender the advance amount, plus fees.

Because invoice financing is backed by your invoices, it can be easier to qualify for compared to other types of business loans. However, invoice financing tends to cost more than other types of financing.

The Takeaway

Inorganic growth involves buying or joining forces with other businesses or opening new locations. It contrasts with organic growth, which is growth from within the company. Both inorganic and organic growth may involve outside financing. However, inorganic growth generally requires significantly more capital than organic growth.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the difference between organic growth and inorganic growth?

Organic growth happens over time and involves using internal resources to increase revenues and customers. Inorganic growth, on the other hand, happens quickly and typically involves acquiring, merging with, or partnering with another company.

What is a benefit of inorganic growth?

Inorganic growth enables your business to expand rapidly, since the company you acquire or partner with typically already has established systems, customers, and revenues.

What are the methods of inorganic growth?

Inorganic growth strategies include acquisitions, mergers, opening a new location, joint ventures, and strategic alliances.

Photo credit: iStock/filadendron

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q424-014

Negative working capital is when a company’s current liabilities are greater than its current assets. Current liabilities are those that are due in less than 12 months. Current assets are those that can turn into cash in less than 12 months.

It’s easy to think that companies with negative net working capital would be at financial risk, but that’s not necessarily the case. There are many situations where having occasional and controlled negative working capital can actually work in a business’s favor.

Read on for an in-depth look at what it means to have negative working capital, when it can happen, and whether it’s a good or bad thing for your small business.

What Is Negative Working Capital?

Working capital is the difference between a business’s current assets and current liabilities.

Working Capital = Current Assets – Current Liabilities

A current asset is an asset that can be easily converted to cash within a year. Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, prepaid liabilities, and other liquid assets. A current liability is any debt that is expected to be repaid within a year. Current liabilities include obligations such as accounts payable and amounts due to suppliers, employee wages, and payroll tax withholding.

Ideally, current assets should be greater than current liabilities but for many businesses, that’s not always the case.

Negative working capital is when a company’s current liabilities are greater than its current assets, as stated on the firm’s balance sheet. While that may sound like a risky proposition, some businesses are able to dip into periods of negative working capital without any ill effects.

Negative working capital commonly arises when a business generates cash very quickly because it can sell products to its customers before it has to pay the bills to its vendors for the original goods or raw materials. It then uses that cash to purchase more inventory or expedite growth in other ways. By doing this, the company is effectively using the vendor’s money as an interest-free loan. The firm still has an outstanding liability, however, which means it can end up with negative working capital.

Positive Working Capital

Positive working capital is when a company’s current assets exceed its current liabilities. It’s the opposite of negative working capital and is usually a good position for a company to be in. Positive working capital means your business will be able to fulfill its financial obligations in the coming year and still have cash leftover to deal with any market disruptions (or other challenges) and/or invest in growth.

In order to be approved for a small business loan, businesses usually need to have a positive working capital, since many loans require assets as collateral. If the business is upside down on its debts vs. its assets, it may have trouble getting approved. However, working capital is one of many factors that lenders look at when approving loans.

Is it possible to have too much positive working capital? Yes. If assets are sitting somewhere and not helping the business grow and generate further revenue, then it’s possible they could be better used elsewhere to fuel the company’s next phase of development. To be competitive in today’s market, leveraging growth for healthy, steady business expansion is often essential.

Zero Working Capital

Zero working capital is when a company’s current assets are the same amount as its current liabilities. Having zero working capital can be a good sign, suggesting that the company is managing its resources effectively, maintaining just enough liquidity to cover its short-term obligations without tying up excess capital in non-productive assets.

However, having zero working capital can also signify that the company is operating on thin margins and doesn’t have much room for error. If unexpected expenses arise or if there’s a downturn in sales, the company could face liquidity problems.

Sometimes, a company might intentionally maintain zero working capital for a short period, perhaps to finance a specific project or investment. However, this is typically not a sustainable long-term strategy.

How to Calculate Negative Working Capital

Negative working capital is calculated by subtracting current liabilities from current assets. If liabilities exceed assets, the result is negative working capital. The formula is the same as the formula for working capital, with the end result being negative:

Negative Working Capital = Current Assets – Current Liabilities

Here’s a negative working capital example:

A gaming retailer buys $1.5 million worth of the latest console directly from the manufacturer. It sells every console within the first day, but doesn’t have to pay its bill for the next 45 days. So it uses this influx of cash to buy more consoles and further increase revenues. In this case, negative working capital works because sales are growing. As a result, this retailer should not have trouble meeting its short-term financial obligations as they become due.

Recommended: How to Calculate Cash Flow

How Negative Working Capital Arises

While negative working capital might seem alarming, there are situations where it can be a strategic choice or a temporary condition. Here’s a look at some reasons why a company might have negative working capital.

•  Industry norms: Some industries naturally operate with negative working capital due to their business models. For example, retail businesses often collect cash from customers before paying suppliers for inventory. This allows them to operate with negative working capital, using suppliers’ credit to finance their operations.

•  Rapid growth: A company experiencing rapid growth might have negative working capital because it’s investing heavily in inventory and receivables to support increased sales. While this can strain short-term liquidity, it’s often seen as a sign of expansion and can be managed if the growth trajectory is sustainable.

•  Seasonal variation: Businesses that experience seasonal fluctuations in sales may have negative working capital during slow periods when they build up inventory and receivables in anticipation of higher demand.

•  Efficiency goals: In some cases, companies deliberately manage their working capital to optimize efficiency. They may prioritize cash flow by delaying payments to suppliers or accelerating the collection of receivables, even if it results in negative working capital on their balance sheet.

When Is Negative Working Capital Good vs Bad?

As mentioned, negative working capital can either be good or bad. Let’s take a closer look at why.

Good Negative Working Capital

Negative working capital can be a good thing when companies are able to sell their inventory faster than their suppliers expect payment. This cash surplus allows the company to purchase more inventory or spur growth in other ways. In this scenario, the vendor is essentially financing part of the company’s operating and investment expenses — similar to a zero-interest loan.

Negative working capital can also provide a company with greater flexibility and agility to respond to changing market conditions or unexpected expenses, while also allowing it to take advantage of growth opportunities as they arise.

Recommended: Business Loan vs Personal Loan: Which Is Right for You?

Bad Negative Working Capital

As soon as a company is unable to pay its operational costs or suppliers on time, negative working capital can shift from good to bad. Even if a company may have utilized negative working capital in the past without issues, a hiccup in sales can hurt operations fast. Negative working capital leaves a company with minimal cushion to absorb the unexpected.

If a business must constantly delay payments to vendors and suppliers, it could strain relationships with those partners. Over time, suppliers may become reluctant to extend credit or offer favorable terms, which could affect a company’s ability to secure necessary goods and services.

Recommended: 15 Types of Business Loans to Consider

Which Industries Typically Have Higher Negative Capital?

Companies with rapid turnover of inventory or services and make their money through cash often have negative working capital. This includes large food stores, retailers, fast food restaurants, service-oriented business, e-commerce companies, and software companies.

Strategies for Dealing With Negative Working Capital

To stay on top of negative working capital, business owners may want to:

1.   Fully understand the flow of cash within your company. Using a business balance sheet to track income and expenses can help you pinpoint money issues that could contribute to negative working capital.

2.   Keep track of account receivables.

3.   Analyze how long it takes to completely sell through inventory batches.

4.   Optimize billing cycles to space out expenses to match estimated sales.

Recommended: How Much Does it Cost to Start a Business?

The Takeaway

Negative working capital is a state in which a company’s current liabilities exceed its current assets. Negative net working capital is fine as long as a company is able to pay its operational expenses and suppliers on time. If it is unable to do so, however, its long-term financial health may be in jeopardy.

While negative working capital can offer certain advantages in terms of cash flow management and flexibility, it’s essential for companies to carefully monitor and manage their working capital levels to avoid potential pitfalls and maintain financial stability.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What does negative working capital indicate?

Negative working capital can indicate a business has a high inventory turnover, meaning it’s able to sell off inventory before any amount is owed to the supplier. On the other hand, it can also mean that the business is having difficulty receiving on-time payments from its customers.

Is negative working capital typically a bad thing to have?

Not necessarily. Businesses in retail or fast-moving consumer goods often operate with negative working capital because they receive payment from customers before paying their suppliers. However, negative working capital can also signify liquidity issues, financial distress, or strained supplier relationships if the company is unable to meet its short-term obligations.

Can working capital being too high be a problem?

Yes. High working capital often means that a significant portion of the company’s assets is tied up in short-term assets like cash, accounts receivable, and inventory. If these assets are not being efficiently utilized, it can lead to lower returns on investment and reduced profitability.

Photo credit: iStock/designer491

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q424-006

The minimum credit score for a business loan typically ranges from 500 to 680, depending on the lender and loan type. Traditional banks often require higher scores (around 680 or more), while alternative lenders may accept lower scores (500-600). Higher credit scores improve loan approval chances and the offering of better terms.

Lenders may also look at your business credit score. A good business credit score is considered 70 or above, but this will also vary by lender.

Even if your credit scores don’t meet those minimums, or you’re not even sure if you have a credit score for your business, you still have plenty of options. Read on to learn about credit requirements for different types of small business loans and what you can do to build your credit score, if needed.

What Is a Business Credit Score?

A business credit score is used to measure the creditworthiness of your business. Your business credit is linked to you by your Employer Identification Number (EIN), which is how the government recognizes your business for tax purposes.

Like your personal credit score, your business credit score is a measure of your historical reliability with your financial commitments. The difference is that this credit profile specifically tracks your business’s financial history.

Types of Business Credit Scores

There are three credit bureaus that measure your business credit scores: Experian, Equifax, and Dun & Bradstreet. Most credit bureaus will give you a business credit score ranging from 1 to 100. An Equifax business credit report, though, will give you three scores: Payment Index, Business Credit Risk Score, and Business Failure Score.

As a small business, you also might encounter something called a FICO® SBSS (Small Business Scoring Service) score, which uses information from all three bureaus. Not all lenders require a FICO SBSS score, but you will likely need one if you are applying for a loan backed by the U.S. Small Business Administration (SBA). Your FICO SBSS score will land somewhere between zero and 300.

Why Do Lenders Care About Your Credit Score for Business Loans?

When applying for a small business loan, lenders will want to know how risky of a borrower you are. Your business credit score is what lenders will look at to determine your level of risk. The higher your score, the less risky a lender will view you. Typically, businesses with high credit scores will qualify for the best interest rates and terms.

Lenders ideally want to see a business credit score of 70 or higher (on a scale of 1 to 100). But again, if you don’t quite meet the minimum, you still may qualify for the loan, you’ll just pay a higher rate than you would with a higher credit score.

Lenders don’t just look at credit scores, though. They’ll also assess how long you’ve been in business and your annual revenue, among other factors.

Recommended: What Does a Credit Score of 800 Mean?

What Is Considered a Good Business Credit Score?

If a lender wants to see your credit score for business loans, it may look at one (or more) scores from the three business credit bureaus. Each has its own scoring range and its own risk categories.

Fitting into one of these risk levels doesn’t necessarily translate into certain success or assured failure in accessing funds. Higher scores, however, can certainly help your odds, while lower scores can translate into smaller loan amounts, higher interest rates, shorter repayment terms, or being denied approval for the loan.

Whatever your scores, it can be a good idea to shop around and compare business loan rates to make sure you get the best rates and terms possible for your business.

What Impacts Business Credit Scores

Each of the business credit bureaus uses a slightly different formula for determining your credit score for small business loans, but, generally, these factors weigh in:

•   How much debt your business has compared to its available credit

•   Whether you pay bills on time

•   How old your credit accounts are

•   Your industry

•   Your company’s size

💡 Recommended: What Is Debt Factoring?

Credit Score Requirements for Different Lenders

The credit score you need for a business loan depends on the lender and the business credit score system they look at. No matter what your credit score is, though, there are all types of business loans you may qualify for, including ones for businesses with poor credit and first-time business loans.

Let’s look at the FICO credit score (both business and personal) for business loans of different types.

Recommended: What Is an Unsecured Business Loan?

SBA Credit Score Requirements

The Small Business Administration looks at the FICO SBSS credit score for SBA loans like the 7(a) and 504. Here are the minimum requirements set by the SBA (keep in mind that individual lenders may require higher scores):

•   7(a) Small Business Loans: 155

•   Community Advantage: 140

•   Express Bridge Loan Pilot Program: 130

If your business doesn’t have a FICO SBSS score, SBA lenders may look at your personal FICO score (which ranges from 300-850). In that case, you’ll generally need a minimum score between 620 and 650, depending on the type of loan and lender. Those with personal credit scores of 720 or higher typically have the best chance of getting approved for an SBA loan.

Bank Loan Credit Score Requirements

Banks can set their own credit score requirements, and often they’re even more stringent than what the SBA requires. Check for specific bank credit score requirements before applying for a loan.

Equipment Financing Credit Scores

If you don’t have good credit but want to buy equipment, an equipment loan (also called equipment financing) can be a good option. Credit score requirements tend to be less strict for equipment loans because the equipment you’re buying acts as collateral for the loan and therefore reduces the lender’s risk.

A personal FICO credit score of 630 may be enough to secure this type of financing. In some cases, you can qualify for equipment financing with personal credit scores in the low 500s. Keep in mind, though, that you’ll most likely pay a higher interest rate if you have a low credit score because the lender is taking on more risk.

Short-Term Loan Credit Scores

Another option for financing if you don’t have stellar credit is a short-term business loan from an online or alternative lender. These lenders often look less at your credit score for business loans and more at other factors, like your annual revenues.

You may be able to get a short-term loan from an alternative lender with a minimum personal credit FICO score of 600, though you’ll want to keep in mind that the lower your credit score, generally the higher your interest rates will be.

And if you’re a startup, you may be able to find lenders that don’t require any particular credit score for startup business loans. Many won’t list the required credit score on their applications because they’ll work with you based on your other criteria.

Do Personal Credit Scores Matter for Business Loans?

In many cases, yes. When you apply for a small business loan, lenders will often look at both personal and business scores. If your business hasn’t yet established any credit scores, they will just look at your personal credit scores to determine whether your business qualifies for the loan.

What Is a Good Personal Credit Score?

There are three major credit bureaus that each calculate your personal credit score: Equifax, TransUnion, and Experian, and each with its own scoring range.

What Factors Affect a Personal Credit Score?

Each personal credit bureau uses different criteria for credit scoring, but they all generally look at the same factors:

•   Credit utilization: This is how much of your available credit you are currently utilizing. Your credit utilization ratio is calculated by dividing the total revolving credit you are using by the total of all your credit limits. Using more than 30% of your available credit is generally seen as a negative to creditors.

•   Age of accounts: Credit bureaus take into consideration how old your credit accounts are. The older the accounts, the more positive the impact on your credit scores. Because of this, you may not want to close credit accounts, even if you no longer use them.

•   Payment history: Credit bureaus look at whether you have any late or nonpayments on your accounts. Even one missed payment can have a negative impact on your score.

•   New credit: Agencies look at the number of credit accounts you’ve recently opened, as well as the number of hard inquiries lenders make when you apply for credit.

•   Credit mix: Credit scoring models also consider the types of accounts you have, as this can show how well you manage a range of credit products.

What Can You Do if You Have a Low Business Credit Score?

If you don’t need funds right away, a good strategy is to focus on establishing business credit and/or boosting your business credit profile enough to get out of the high risk category.

You can start building business credit by opening trade credit accounts with vendors that report financial activity to the business credit bureaus. This might be an office supply store you frequently purchase products from or the company you buy inventory from.

You can also build credit by opening a business credit card and making timely payments.

If you need capital right away, you also have options. Here are some ways to secure a loan without strong credit.

Put Up Collateral

Some business loans require business collateral, which is an asset you put up against the loan. If you are unable to pay off the loan, the lender can seize that asset to cover your debt. Having collateral lowers the risk for the lender, so you may qualify for a loan even with fair credit.

Provide a Personal Guarantees

Another option is to provide a personal guarantee. This is an agreement that states that, should your business be unable to pay off the loan, you will be personally responsible for paying it off.

Apply for Grants

Small business loans aren’t your only option for finding the money you need. There are also small business grants offered by local and federal governments, corporations, and nonprofits. Business grants do not have to be repaid.

Most grants have specific criteria a business needs to meet, such as being a minority-, women-, or veteran-owned business, or being in a certain industry. Grants also tend to be competitive, so read the fine print to make sure you qualify and follow the application instructions carefully to increase the odds of being selected. You may even want to try a combination of grants and loans to ensure you have the capital you need for your business.

How to Build Your Credit Score

If you want to build your personal credit profile, it can be a good idea to pay your bills on time and work on paying down existing debt, which can help lower your credit utilization ratio.

It can also be helpful to avoid applying for multiple loans or credit cards at the same time, as each one can impact your credit score for a short period. You may also want to periodically check your credit reports. If you see any discrepancy (maybe you paid off a credit card and that’s not reflected on the report), inform the credit bureau right away so your score reflects accurate information.

Are No Credit Check Business Loans Possible?

Yes, it is possible to find a loan that doesn’t look at your credit score. These lenders may look at other criteria, such as annual revenues, to determine eligibility.

These can be great in a pinch, but be aware that no credit check business loans tend to have higher interest rates than traditional loans. Only you can determine whether it’s worth it to pay that expense. If having the money now means you can take advantage of opportunities for your business or get you out of a tough spot, it may be worth the cost.

The Takeaway

While there is no set minimum credit score for business loans, lenders prefer to see good to excellent scores in order to qualify you for the best rates and terms. Because your credit score is a measure of your financial responsibility, it’s one of the key factors that lenders consider in your loan application. Lenders will typically look at both your personal credit scores and your business credit scores, if available.

However, your credit scores are just one part of your business’s financial profile. Lenders will typically take many factors — from your annual revenues to your business plan — into account during the application process. In addition, there are many different types of loans available, so even if your credit scores aren’t excellent, you likely still have options.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Is there a minimum credit score needed to start a business?

There isn’t a minimum credit score (business or personal) required to start a business. However, if you want to take out a business loan, some lenders do have credit score requirements to qualify.

Can you get a business loan with a 600 credit score?

There are lenders who will approve your application if you have a 600 credit score, though banks and SBA lenders tend to look for scores starting at 620 or higher.

Can you start a business with no credit and no money?

Starting a business with no credit and no money is challenging, but possible. Entrepreneurs can begin by offering services that require minimal capital, like freelancing or consulting, relying on skills rather than assets. If you need a loan, online lenders often have lower qualifications for business loans than traditional banks do.

How can I build my business credit?

You can build your business credit by taking out a business credit card or loan and repaying it on time, as well as by opening trade accounts under your business name with companies that report to business credit bureaus.

Photo credit: iStock/JLco – Julia Amaral

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

SOSMB-Q324-058

Accounts payable are bills and other short-term debts that a business needs to pay. It includes all of a company’s current liabilities (due within one year), making it a key component of small business accounting.

Understanding accounts payable and having a dependable accounts payable system is essential to running a successful small business. Here’s what you need to know.

What Is Accounts Payable (AP)?

When a business buys goods or services from a vendor or supplier on credit that needs to be paid back in the near term, the accounting entry is known as “accounts payable.” On a balance sheet, accounts payable appears under current liabilities.

Accounts payable differs from a loan payable in that accounts payable does not charge interest (unless payment is late) and is typically based on goods or services acquired. Loan payables, such as balances on various kinds of small business loans, generally charge interest and are based on the prior receipt of a sum of cash from a lender.

In a company, the term “accounts payable” is also used as the name of the department responsible for handling vendor invoices and bills — from recording them in the general ledger to making payments to suppliers and other third parties.

Recommended: Guide to Vendor Financing

Is Accounts Payable an Asset or Liability?

In small business accounting, accounts payable is a liability since it is money owed to vendors and creditors. The account grows larger when more money is owed to vendors. When accounts payable increases, a business will typically have more cash on hand because of the delay in paying amounts owed. This typically results in a temporary increase in liquidity.

The short-term debt in accounts payable can help keep cash on hand to pay for other items, but eventually creditors will require payment.

Accounts payable differs from business expenses in that accounts payable is shown on a business’s balance sheet, whereas business expenses are shown on the income statement.

Recommended: Small Business Balance Sheets with Examples

How Accounts Payable Works

When a business purchases goods or services from a supplier on credit, also known as trade credit, payment isn’t made immediately. Typically, it will be due within 30 or 60 days, sometimes longer.

Here’s how it works:

A business will send the supplier a purchase order. The supplier will then provide the goods or services the business purchased, along with an invoice requesting payment by a certain date. The person or department responsible for accounts payable will verify the invoice against the purchase order and ensure the goods or services were received before issuing payment to their vendors.

If amounts owed to suppliers and other third parties are not paid within the agreed terms, late payments or defaults can result.

The sum of all outstanding payments owed by a business to third parties is recorded as the balance of accounts payable on the company’s balance sheet. Any increase or decrease in accounts payable from one accounting period to another will appear on the cash flow statement.

Recommended: How to Calculate Cash Flow

4 Steps of the Accounts Payable Process

Managing business finances is one of the most important aspects of running a small business. The accounts payable process has four key steps. Going through this defined process helps avoid errors and missing a payment deadline to a vendor.

1. Invoice Capture

The accounts payable process generally begins when a supplier or third party submits an invoice to the accounts payable department. After receiving the invoice, the accounts payable clerk will verify the invoice is valid and not a duplicate, code the invoice to the general ledger, and, depending on the company’s process, conduct a two-way match (in which invoices are matched to purchase orders) or a three-way match (in which invoices are matched to purchase orders and receiving information).

2. Invoice Approval

Once all the data is entered, an invoice must be approved. This involves an individual from the accounts payable department routing the invoice to the appropriate person (or people) in the company to get the necessary approval(s).

3. Payment Authorization

After an invoice is approved, the accounts payable clerk may need to get authorization to make a payment. The authorization will typically include the payment amount, method of payment, and date the payment will be made.

4. Payment Execution

Once payment is authorized, the invoice can be paid. Payment should be processed before or on the bill’s due date and may be done by check, electronic bank-to-bank payment, or credit card. Once the invoice is paid, it can be closed out in the accounting system.

Recommended: Debt-to-EBITDA Ratio Explained

Internal Controls and Audits

Internal controls are standardized operating procedures used by companies in their accounts payable process to reduce the risk that a business will pay a fraudulent or inaccurate invoice, pay a vendor invoice twice, and/or fail to pay an invoice on time.

These controls often include:

•  Purchase order approval

•  Invoice approval

•  Two-way matching (in which invoices are matched to purchase orders) or three-way matching (in which invoices are matched to purchase orders and receiving information)

•  Auditing for duplicates (which involves checking files manually or with an accounts payable automation platform to make sure duplicate payments aren’t made)

Accounts Payable Examples

Generally, any items bought on short-term credit fall under the accounts payable umbrella. This includes:

•  Licensing costs

•  Leasing costs

•  Subcontractor bills

•  Amounts owed for raw materials and fuel

•  Products and equipment received but not paid for

•  Subscription services

•  Installment payment plans

💡 Recommended: Guide to Vendor Financing

Accounts Payable vs Accounts Receivable

Accounts receivable is basically the opposite of accounts payable. While accounts payable is the money a company owes to suppliers and vendors, accounts receivable is the money that is owed to the company, generally by its customers. If two companies make a transaction on credit, one records it to accounts payable, while the other records it to accounts receivable.

Here’s a side-by-side comparison of accounts payable vs accounts receivable:

When a business owner needs an influx of cash, accounts receivable financing is a type of financing that enables them to receive early payment on outstanding invoices. The owner must then repay the money (plus a fee) to the financing company when they receive payment from their customers.

Recommended: GAAP Explained

Trade Payables and Accounts Payables

Though they sound similar, trade payables are actually slightly different from accounts payables.

Trade payables are amounts a company owes its vendors for inventory-related goods, such as business supplies or materials that are part of the company’s inventory. Accounts payables, on the other hand, includes trade payables, as well as all other short-term debts.

The Takeaway

Accounts payable is a current liability on a company’s balance sheet. It includes all of the short-term credits extended to a business by vendors and creditors for goods or services rendered but not yet paid for. Accounts payable also refers to the department or person in a firm that records and handles purchases and payments.

Lenders and potential investors will often look at a company’s accounts payable, as well as their accounts receivable, to gauge the financial health of a business. Mismanagement on either side of the equation can have a negative impact on your business’s ability to get credit or get approved for a small business loan, and could also put your business at risk.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What are examples of accounts payables?

Any good or service that is purchased by the company on short-term credit should be listed as accounts payable on the balance sheet. Some examples include:

•  Leased vehicles

•  Subcontractor services

•  Equipment

•  Materials

•  Business supplies

•  Subscription services

What is the purpose of accounts payable?

The purpose of accounts payable is to accurately track what’s owed to vendors and suppliers and to ensure that payments are properly approved and processed. Having accurate accounts payable information is essential to producing an accurate balance sheet.

What is accounts payable reconciliation?

Accounts payable reconciliation is a process in which the accounts payable department verifies that the detailed total of all accounts payable outstanding matches the payables account balance stated in the general ledger. This is done to ensure that the amount of accounts payable reported in the balance sheet is accurate.

Photo credit: iStock/Panuwat Dangsungnoen

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q324-051