How Credit Ratings Work for Small Companies

Most small and mid-size businesses never receive a public credit rating from Moody’s, S&P, or Fitch. The cost, disclosure burden, and limited benefit make it uneconomical—unless the company plans to borrow through capital markets. Instead, how credit ratings work for small companies relies on bank-internal scoring, due diligence, and private placements that never see the light of a formal rating.

Why public ratings are rare for small companies

A public credit rating from a major agency is expensive and cumbersome. The agency conducts a detailed review of financials, competitive position, management quality, and operational risk—a process that costs tens of thousands of dollars upfront, plus annual surveillance fees. For a bank or capital markets borrower, this cost is justified because a rating allows them to issue bonds to thousands of investors, each of whom needs reassurance about credit quality.

For a small company, the math does not work. If a mid-market manufacturer borrows $20 million from a single bank, the bank does not care about a public rating—it does its own due diligence and sets the interest rate based on its internal view of risk. The company saves the $20,000+ in annual rating fees and avoids the SEC filing burden.

Public ratings became standard only when firms grew large enough to tap capital markets directly. A company issuing a $500 million bond to investors worldwide needs a third-party rating; a company borrowing $20 million in a term loan does not.

Bank-internal credit ratings: the reality for most small companies

When a small business applies for a loan, the bank runs it through an internal credit-scoring model. This model is proprietary to the bank—it might be a questionnaire, a quantitative scorecard, or a combination. The bank’s credit analyst interviews management, reviews three to five years of audited or reviewed financials, assesses cash flow, collateral, and industry risk, and assigns an internal rating.

These internal ratings vary by bank. Some use a 1–10 scale; others use letter grades (A, B, C, D); still others use a probability-of-default framework. But the process is consistent: the bank asks whether the company will repay, on what terms, and what happens if industry conditions deteriorate.

The bank’s internal rating directly affects the loan price. A company rated internally as low-risk might get a loan at SOFR + 250 basis points; one rated as higher-risk might be quoted at SOFR + 500 basis points. The spread reflects the bank’s risk assessment—even though no public rating exists.

Banks do not disclose their internal ratings to the borrower, though a sophisticated borrower can infer the rating from the spread offered. If multiple banks quote similarly tight spreads, the company is rated favorably; if quotes are wide and conditional on collateral, the company is rated as riskier.

When a public rating becomes worthwhile

A company needs a public rating once it plans to:

1. Issue bonds to institutional investors. If you want to raise money from pension funds, mutual funds, or insurance companies, they demand a third-party rating. The rating signals that the company has passed professional vetting and agree to ongoing disclosure.

2. Refinance large existing debt. A company with $200 million in outstanding bank debt might refinance into bonds and need a rating to expand the investor base and potentially lower the cost of capital.

3. Make a major acquisition. A merger or acquisition often requires a rating to explain the combined entity’s creditworthiness to lenders and ratings agencies.

4. Access public capital markets for other reasons. Some companies want the prestige of a rating even if borrowing is not imminent, to be “rating-ready” for opportunistic issuance.

The threshold is roughly $100 million in revenue and $20+ million in annual EBITDA, though it varies by industry. A commercial real estate firm might issue a rated bond at $50 million EBITDA; a manufacturing firm might wait until $100 million.

Private placements and boutique ratings

Between bank loans and public bond issuance, there is a middle tier: private placements to a limited number of institutional investors. These deals might involve 5–20 large investors, no public rating, but a detailed prospectus and often a rating from a smaller boutique agency.

Some private placements are unrated, with investors conducting their own due diligence. Others receive a rating from a smaller firm like Kroll Bond Rating Agency or Egan-Jones, which operate outside the “big three” (Moody’s, S&P, Fitch) but still provide third-party credibility.

These private ratings cost less than a public rating (perhaps $10,000–$30,000 annually) and require less ongoing disclosure. The company provides financial statements and a management presentation; the agency produces a brief rating report. Investors use it as a data point but conduct their own checks as well.

Collateral and covenants as surrogates for ratings

Small companies without public ratings rely more heavily on collateral and covenants to manage lender risk. A company might pledge equipment, real estate, or accounts receivable as security. Restrictive covenants—requirements to maintain certain leverage ratios, interest coverage, or debt-to-EBITDA—limit the company’s flexibility but reassure the lender.

In contrast, a company with a public investment-grade rating faces fewer collateral demands and looser covenants because the rating itself is the proof of creditworthiness. The absence of a public rating shifts the lender’s reliance toward collateral, covenants, and management quality assessments.

Disadvantages of being unrated

Companies without ratings face higher borrowing costs, less certainty in refinancing, and reduced access to debt capital. A bank might decide not to lend to an unrated company if it does not understand the industry well, or might require 200–300 basis points of excess spread compared to a rated peer.

Unrated companies are also more vulnerable to credit market freezes. During a credit cycle downturn, banks tighten credit standards and reduce lending to unrated small companies first. A rated company can issue bonds even in difficult markets; an unrated company might find bank credit wholly unavailable.

Acquisitions become harder for unrated companies as well. If a buyer wants to borrow to finance a deal, lenders will scrutinize an unrated target company more carefully, potentially killing the transaction or forcing a lower price.

Cost-benefit: why most small companies stay unrated

Despite these disadvantages, most small and mid-size companies never seek a public rating. The economics are simple:

• Cost: Annual rating fees of $15,000–$50,000+, plus one-time legal and audit fees.
• Benefit: Lower borrowing costs on capital-markets debt (bonds), but the company is not currently issuing bonds, so there is no immediate benefit.
• Disclosure burden: Public debt triggers SEC filings and public financial statements, reducing privacy and exposing competitive information.

Unless the company has a near-term capital markets borrowing plan, paying for a rating generates no return. When the company grows and finally needs a public rating, it can apply then.

Transition: from bank loans to public ratings

A typical path is:

1. Years 1–5: Bank loans, internal ratings only. The company borrows $5–$20 million from a single bank relationship, based on the bank’s credit analysis.

2. Years 5–10: Syndicated loans, still no public rating. The company grows and borrows $50–$100 million. Multiple banks syndicate the loan; the agent bank leads a due diligence process, but no public rating is needed (syndicated loans trade on credit agreements and bank relationships, not ratings).

3. Years 10+: Capital markets debut. The company reaches $150+ million EBITDA and wants to refinance into a lower-cost bond. It hires a rating agency, goes through the formal process (3–6 months), receives a rating, and issues bonds.

Once a company has a public rating, it must maintain it. This means filing financial statements on time, hosting investor calls, and keeping the rating agency informed of material changes. The rating becomes a public measure of credit quality, and the cost of losing it or being downgraded is high (it signals distress and can trigger refinancing risk).

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