Rebuilding Credit to run Your new Business

Dear Your Business Credit,

I am in the process of starting my own online record label. I know the importance of having a business bank account separate from a personal one. I'd just like to ask: If my credit is shot, how can I apply for and get a business credit card to be able to separate it from my personal account? I have bad, bad credit. Or is there absolutely no way of doing so? Thanks so much for your help with this question. Any suggestions/feedback would be absolutely wonderful.

- Lin

Dear Lin,

Don't get discouraged.

Michael Jeffrey Gunderson, a bankruptcy attorney with Gunderson & Tharp in Chicago, says he often works with small-business owners who have run into problems with their credit -- and it's very possible to turn things around.

There are a couple of credit card options for people who are trying to repair their credit. The best route is a secured credit card. For these cards, you make a security deposit the card issuer can use to pay your debt if you fall behind on the bill. For a secured card with a $500 limit, you might make a deposit of $500 and then be free to charge up to that amount. Sometimes you might get a credit limit higher than your deposit. "It doesn't work like a debit card," Gunderson notes. You would use it like a regular credit card -- and pay it off monthly. You can compare terms for many secured cards on CreditCards.com's secured card comparison page.

Another option is a low-limit card. These cards typically offer maximum credit lines in the $300 to $500 range, but they should only be used as a last resort. While the Credit CARD Act of 2009 caps first-year fees to 25% of available credit, issuers have gotten around that rule with application fees that don't fall under that cap.

The First Premier Bank Gold credit card, for instance, will give you a credit limit up to $300. But first you have to pay a $95 processing fee and a $75 annual fee. So you're forking over $170 to get that $300 line of credit. The cards do report on-time payments to the credit bureaus, so they can help rebuild your credit, but at a very high cost.

Once you build up a strong history of timely payments, your credit score should improve, giving you access to a wider range of credit card deals.

That's just one part of improving your credit score, though. If you have outstanding credit card debts, it's important to pay them down in a timely manner, to reduce your overall credit utilization ratio, Gunderson says. Your credit score is based, in part, on how much of your available credit you use.

To head off future credit problems, pay close attention to how you manage debt and cash flow in your business. "The biggest mistake is taking on too much debt, too soon," says Gunderson.

While borrowing small amounts to fill gaps in cash flow is fine, don't rely on plastic as your major form of financing. Think of it as one tool in your arsenal -- a small one. "It's more of a Swiss Army knife, as opposed to a fork lift," he says.

Where many small-business owners get in trouble, he says, is borrowing heavily to finance a new venture before it is bringing in much money. With limited revenue, they find it hard to keep up with monthly credit card and loan payments.

In a business such as yours, securing about $1,000 in credit lines on credit cards, using it for routine gasoline and stationery purchases, then paying it off monthly can help you build good habits without too much risk. As sales grow, you will be able to take on more debt safely -- as long as you do it gradually, Gunderson says.Your use of credit "should be commensurate with how the business is doing and never more," he says.

Make sure you take into account the likelihood that you will have unsteady cash flow -- and significant overhead -- in running your business. If you bring in $50,000 your first year in business, your financial situation will be very different from a friend in a traditional job who earns $50,000. While your friend may be able to count on paychecks every week or two, your customers will likely pay you at varying speeds -- and if they hit a rough spot, it may take months. It's just a reality of doing business. "Small-business owners typically do not have uniform pay like someone in a traditional job would," says Gunderson. "It's often feast or famine."

To avoid relying too heavily on credit cards to get you through periods of slow cash flow, you'll need to keep more cash in reserve. It's also important to stay on top of invoicing. The quicker you get paid, the more money you'll have in your bank account.

Some business owners have come up with payment plans in which customers pay upfront and get a discount for doing so. This obviously is beneficial for cash flow.

Make sure you don't overlook big expenses in your business and personal life that may affect how much money you have available to cover business expenses. Unlike a friend whose employer deducts taxes from his paycheck, you'll need to set aside money to pay your taxes yourself. And if you need health insurance and can't get it through a spouse or parent (if you're under 26), you may need to pay for it out of pocket. It's never cheap.

That means you'll probably need to live below your means, which takes discipline. But it can have a big payoff for your business.