Business lending covers a pretty large gambit. It encompasses a small business that may need some credit to purchase a vehicle or equipment, up to large private companies who manage vast portfolios of commercial real estate. When I am looking at a multimillion dollar request, I sometimes crack a smile when someone asks about the credit score of one of the project owners. Could a credit score really make or break the success of an office building, hotel, or manufacturing facility?
I don’t see this question as purely rhetorical, and there may be instances when it is arguably important. But first, we need to understand what a credit score is before we speculate how it affects business lending. A credit score is an attempt to understand the risk of lending to you by using standardized information about you, and comparing it to the same set of information that can be applied to everyone else. When we say everyone else, we should pay special attention to what that indicates.
Everyone, in an American sense, means most of us who probably own a car, probably have a credit card, usually have a job that pays us twice a month, and have likely graduated high school. Most of us share these common characteristics, so it is easy to anticipate the likelihood of a loan getting repaid when we look at how everyone else might have fared in the same situation. But, people borrowing for business purposes are different, and that fact alone distinguishes them. How many people do you know own a restaurant? How many people do you know own an apartment building? You might know one or two people like that, but they are not representative of everyone.
So, a credit score generally assesses the likelihood of a loan getting repaid, if the loan is for a standard reason we all borrow. In other words, it is a measure of our ability to repay consumer credit. But for people who are not borrowing for an ordinary consumer purpose, it doesn’t factor in other valuable information. The credit score cannot give us an idea of how much equity someone has in a real estate investment, or how much cash savings someone has to fall back on in hard times. Rather, a credit score is a narrow assessment of how many people can do one thing, which is repay a consumer loan.
Then if a credit score is consumer measurement, how relevant is a credit score in business lending? For small business owners who need credit for purchases like vehicles and equipment, a credit score might actually be a reasonable indicator of repayment, because small business purchases are more akin to consumer credit needs. But the larger the request becomes, and the more removed from consumer credit the request becomes, and then the score itself may have little importance on its own. But, there might be a reason to have concern if someone has a poor credit score and he/she wants to borrow millions.
If someone has a poor credit score, it might give us some insight into their character. No matter how large their borrowing need is, it is a bit concerning that someone may not be paying their small bills. It may be the case they really don’t have the extra money, or they simply don’t care to. Sometimes, the score is low because of a tax lien or judgement, which is a serious concern. However, sometimes there isn’t much cause for concern. Even I irrationally had a lower credit score once, simply because I had medical bill fall into collection, because they never sent the bill to my address so I knew to pay it! Borrowers might have a low score, but for explainable or immaterial reasons.
So, is a credit score relevant in business lending? For small businesses, yes, it tells us something about repaying small loans. For large business loans, the score alone is much less significant. But if there is an adverse score, generally a reason should be provided as to why this is the case. But ultimately, a credit score cannot give me meaningful feedback about whether an apartment building will lease up, whether the demand for widgets will go up or down, or whether 2016 will be a good year for crops. To determine these things, we need a more detailed underwriting process, and a credit score is a small item to consider in a much greater picture.