Assessing Risk for Thin File Business Onboarding

In brief: 

• “Thin file” refers to a person or business that doesn’t have a lengthy (recent) history of credit-based transactions. This can affect the entity’s ability to borrow money or be approved for credit cards, because it represents potential high credit risk due to a lack of relevant information. It can also hamper a business’s efforts to get onboarded by another organization as a customer or partner, for the same reason.
• Businesses may have thin credit files (but potentially good credit scores) for reasons such as being new, moving from a different country, dealing primarily in cash instead of credit, and/or being successful enough to not need credit for an extended period of time. However, the lack of concrete evidence still makes it difficult to tell if these reasons are honest or are potentially being used to conceal fraudulent activity.
• An organization wanting to assess the financial risk of a thin file business can look for information in other places. These include sanctions lists or financial watchlists, bankruptcy filings, business liens, past or active litigation, and negative press coverage.

When an organization wants to onboard another business as a customer or partner, one of the key aspects of KYB (Know Your Business) required for effective due diligence purposes is how the business manages its finances. Part of that likely involves ordering a credit report on the business. But what if circumstances at the business mean there isn’t much reliable information regarding its credit history?

This is a case known as a “thin file” business, and it can result in an organization having difficulty conducting a proper verification process before onboarding the business. While some businesses have genuine justifications for having thin credit files, others may be trying to hide unlawful activities.

Fortunately, there are other places an organization can look for information in order to assess the potential risk of a thin file business. This article discusses some of them.

First, we’ll give a more specific “thin file” definition, including some reasons why a business may have a thin file of credit.

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A “thin file” refers to a person or business without a substantial history of credit-based transactions, such as loans or credit card payments. This lack of information makes it difficult for credit rating agencies to accurately determine the credit score of the person or business.

A thin credit file can be especially problematic for a business, as it doesn’t just affect the business’s ability to borrow money or pay for things on credit. It can also impact the business’s chances of being onboarded as a client or partner by another organization. This is because a thin credit file may (but not always) be interpreted as a high risk factor in terms of due diligence, as an organization can have difficulty verifying the business’s creditworthiness.

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Many fraudulent businesses have thin credit. The idea for them is to intentionally not leave much of a paper trail that creditors or business partners could trace back to bad credit histories or illegal activity. Instead, they rely on these parties giving them the benefit of the doubt, and then taking unfair advantage of it.

However, a business (or individual, for that matter) having a thin file does not always mean it’s risky to extend credit to. It could actually have a good credit score but a thin file. So while it has been good at repaying borrowed credit, it has just done so too infrequently for creditors to objectively judge whether or not this behavior is consistent.

There are some legitimate reasons why a business may have a thin file for its credit history. They include:

• It’s new and hasn’t had a chance to conduct many credit-based transactions
• It transferred from another country (but its credit scores and histories didn’t)
• It’s inactive, so it hasn’t conducted many credit-based transactions in a while
• It’s successful enough that it hasn’t needed to borrow credit for a while
• It deals primarily (or exclusively) in cash instead of credit

Unfortunately, illegitimate businesses can often have a number of these same traits. This is one of the difficulties of assessing the risk associated with onboarding a thin file business.  

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There are three main challenges with verifying a business that has a thin credit history.

1. Lack of information

The biggest issue in verifying a thin file business is there just isn’t as much credit history information to work with. This makes it difficult for credit bureaus to objectively assign the business a credit score – a measure of how likely the business will repay its debts on time and in full. It also precludes being able to adjust the business’s credit score over time, revealing a pattern of how the business’s creditworthiness has changed over its lifecycle.

An organization that doesn’t have this information on a business may, rightly or wrongly, consider the business too high-risk to onboard. This is because it doesn’t have an accurate indicator of how well the business is able to fulfill its financial (and, by extension, other) obligations.  

2. Lack of authenticity

Businesses may know that having a thin credit profile can make creditors hesitant to lend them credit, or other organizations reluctant to onboard them as customers or partners. Thus, they may try certain techniques to look more creditworthy than they potentially are. This could include making a series of small purchases on credit and then quickly paying them off to artificially inflate their credit scores. They may even go so far as to forge their financial data to appear eligible for more credit and/or backed by a creditworthy – but either fake or stolen – identity.

Small businesses may not have had this information audited and verified by third parties – if they’ve submitted it at all. So even if the information exists, it’s difficult for organizations doing onboarding risk assessments to trust its credibility.

3. Lack of context

As we mentioned, there can be justifiable reasons for a business having a thin credit report. However, fraudulent businesses can have thin files for many of the same reasons. So with little information to go off of, it can be challenging for an organization to determine whether a business has a thin file for legitimate reasons or because it’s doing something shady.

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Given the issues mentioned above, how can an organization properly onboard a business that has a thin credit score? The answer is to look for signals in other places, and use a tool like Middesk, to verify the other aspects of the business you can find information on.

Credit score isn’t the only determining factor to whether or not a business is legitimate. There are other pieces of information that can point to a business being financially trustworthy, or legitimate to work with. Middesk is one of the most effective ways to gather all the information necessary to determine if a business is legitimate, as it’s more difficult to conduct proper risk assessment if you only have their credit score information, or have only verified their EIN.

An organization needs to consider this evidence together with any credit data available on the business, as well as the organization’s own risk appetite. This is the best way to avoid small business credit risk when existing data is limited. Utilizing a tool that can verify the information points below can help you accurately assess the risk associated with onboarding your potential customer with a thin credit file.

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What kinds of information should an organization look for when trying to supplement limited credit information on a business? Here are five suggestions:

1. Sanctions lists and watchlists

Governments and international organizations publish lists of individuals, businesses, and even countries they deem dangerous – or even illegal, in the case of sanctions lists (such as those from OFAC) – to conduct commerce with. At most, organizations need to avoid running afoul of the law by not dealing with businesses, the people who run them, or the countries that house them that are on sanctions lists. 

At least, an organization should be cautious and do enhanced due diligence to determine why a person, business, or country is on a watchlist. It may have a history of fraudulent activity, or at least of failing to adequately protect its services from being used by criminals. In any case, presence on a sanctions list or financial watchlist is a strong signal that a business – or at least its owners or home country – may be too risky to onboard.

2. Bankruptcies

A business in the middle of a bankruptcy filing is probably not a smart one for an organization to try to onboard. A bankruptcy signals that a business is unable to meet its financial (and, consequently, operational) obligations, at least for the time being. It may even be trying to abuse bankruptcy protection to commit fraud.

To be thorough, an organization should look into the financial histories of a business’s ultimate beneficial owners. It may be able to spot a pattern of suspiciously frequent bankruptcies in businesses owned by a particular person, which can be an indicator of fraud or other risk.

3. Liens 

Liens are notices of legal claims against an entity’s assets due to unpaid debts. They can be consensual (e.g. a business loan for office space or equipment), statutory (e.g. when an entity fails to pay their taxes), or created by a judgment made in a lawsuit.

An organization can look at the type, value, collateral, and deadline of liens against a business for insights into that business’s financial decision-making. These could include how likely the business is to repay the debt, and how heavily its operations would be impacted if it fails to do so. This, in turn, would allow an organization to evaluate the risk of onboarding a business and then potentially having the business be unable to fulfill its obligations. 

4. Litigations

If there’s an open litigation against a business, that could signify shady activity. At the very least, it may draw negative attention to the business, which could cost it commerce. It may also result in a judgment lien being filed against the business, which would cost the business money or even other assets it needs to operate. So this can be a significant red flag.

Like with bankruptcies, it may also be useful for the organization to look for potential past litigations against the business or its owners. If the organization finds a pattern of past legal troubles, it may decide that dealing with a business – or at least the people who run it – isn’t worth the risk.

5. Adverse media coverage

An organization may also be able to use negative news stories about a business, its owner(s), or its home country as evidence for assessing the financial risk of forming a relationship with that business. At the very least, bad press could cause the business reputational damage, which could lead to lost customers and/or sales. It could also be an even stronger warning about the business’s creditworthiness if it involves financial misconduct.

Note that the timing of the coverage can affect its reliability as risk assessment evidence. If it was a long time ago, it may not be relevant as the situation at the business may have changed. Conversely, if it was fairly recent, the information may just be based on what the news media knows so far and may not represent the full extent of the story.

Get the extra contextual information needed to verify thin file businesses from Middesk

Middesk’s Business Verification solution provides the data needed to help verify businesses with thin credit files. These include not only the types of information above, but also other details regarding whether a business is legally allowed to operate at all.

To see how we can level up your business verification processes, contact our sales team.