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Is Business Credit Scoring A Killer Application Or Application Killer?
By: George A. Parker
In his 1968 seminal novel, 2001: A Space Odyssey, Arthur Clark introduced HAL, a
spaceship computer with artificial intelligence. Mission engineers designed HAL
to carry out an array of technical orders to safeguard the ship’s mission. HAL
operated flawlessly until it reported the failed operation of a ship system that
was operating perfectly. Rather than correct the mistake, HAL’s logic dictated
that it would be more efficient to kill the ship’s crew. Ever the polite
computer, HAL killed quickly and quietly until it was unplugged by the sole
remaining crewmember, Dave Bowman.
Many small business owners believe that HAL’s progeny are carrying out HAL’s
murderous mission in the small business credit arena. Computers now make
important credit decisions for major banks and financing companies. Each day in
the U.S., computers with fancy algorithms score thousands of small business
credit transactions. Though credit-scoring models work well for most small
companies, many believe these systems, like HAL, have run amuck. Routinely,
transactions with low scores are turned down and applicants are notified of the
decision by computer-generated rejection letters.
By gaining a better understanding of the credit scoring process, you may be able
to help your firm maneuver in the new world of credit scoring. Here are some key
points about business credit scoring worth noting:
1. Credit scoring automates the credit evaluation process. Credit providers use
these systems to speed up loan processing, to cut processing costs, to quickly
adjust rates and terms to match credit risks, and to add a high degree of
objectivity to credit decisions.
2. Credit scoring is a predictive system based on statistical modeling. Scoring
systems are designed to forecast whether borrowers will be successful in
repaying loans. Many systems use up to 20 factors to evaluate credit worthiness.
3. Many lenders and leasing companies use credit scoring for business
transactions under $100,000. Over 90% of major credit providers use
credit-scoring systems on transactions below $ 50,000.
4. A pioneer and leading credit scoring service, Fair Isaac and Company,
researched statistical credit modeling in the 1980s. They determined that the
personal credit behavior of a company’s key principals/owners is a strong
predictor of their business credit behavior. Simply stated, a business owner who
pays personal bills on time generally will cause his/her company to pay bills on
time.
5. The Fair Isaac scoring model produces business credit scores ranging from 50
to 350. Credit providers usually consider a business credit score above 220 to
be a good risk. They consider a score of less than 175 to be a high risk.
6. The overriding factor in business credit scoring is the credit history of the
business owners or the key principals. In addition, there are other factors
related to the owners’/principals’ personal credit profiles used to score small
business transactions
7. Business-related credit factors scored include: the company’s time in
business; company size; industry; form of company organization; history of
paying bills on time; business net worth; average bank balances; ratio of debt
service to cash flow; and recent judgments, bankruptcies or agency collections.
8. Many large lenders, such as Well Fargo Bank and Bank of America, have
developed their own predictive business credit models. Several have even
fine-tuned the Fair Isaac model to better meet their needs and preferences.
9. If your firm is rejected for credit based on a scoring model, ask the lender
to explain the rejection. Some lenders will reconsider if requested, but may
require additional credit information.
10. Some lenders have special pools for higher risk credits. They usually charge
higher rates and offer terms that are less advantageous than for high-scoring
transactions. Others may ask for credit enhancements to grant approval, such as
additional collateral or outside guarantees.
11. Here are ten ways to improve business credit scores:
* Improve the credit habits and profiles of the key principals or business
owners
* Pay all back taxes
* Settle outstanding liens and judgments
* Pay bills on time and be consistent with payments
* Eliminate supplier disputes by settling with any suppliers or former employees
* Sell or factor accounts receivable to improve cash flow
* Establish your firm’s credit record by registering with the Secretary of State
where your business is incorporated
* Try to improve individual and company credit for at least twelve months
* Buy from vendors who report activity to the major credit bureaus
* Set up automatic account debiting with creditors to help eliminate the
possibility of paying slow
Credit scoring is not designed to predict individual loan performance with
certainty. Rather, these systems do a great job of quantifying risks for groups
of borrowers with similar characteristics. A disadvantage of credit scoring
systems is that they are easy to misapply. If the lender’s customers don’t share
characteristics and behavior patterns with the model’s underlying base group of
credits, then reminiscent of HAL, many transactions with great potential may be
eliminated.
If your firm doesn’t score well under a scoring model used by a major lender,
you may face an uphill battle for credit approval. Some smaller credit providers
try to differentiate themselves by not using scoring models. Instead, they
actually listen to borrowers, sort out unusual circumstances and use old-fashion
human judgment to make credit decisions. One of these lenders might make sense
for your firm.
About the Author:
George Parker is a Director and Executive Vice President of Leasing Technologies
International, Inc. (“LTI”). Headquartered in Wilton, CT, LTI is a leasing firm
specializing nationally in equipment financing programs for emerging growth and
later-stage, venture capital backed companies. More information about LTI is
available at: www.ltileasing.com. |
