If you have a new idea for a business, or are looking to expand your current business and need additional capital, then starting a conversation with a small business loan lender is an essential step. However, you may be unsure of how to qualify for a small business loan.
As a small business owner, you’re sure to have some questions about qualifying for a small business loan. Lucky for you, I’m here to tell you everything you need to know about how to qualify for a small business loan.
Small business loan qualification differs from large corporations in many ways. Small businesses often don’t have the same resources as large companies to negotiate for better terms. This article will cover the basic requirements of qualifying for a business loan.
Getting a small-business loan can be a time-consuming process. By knowing whether you’ll meet a lender’s qualifications ahead of time, you can avoid potential frustration.Here are five steps to help you qualify for a small-business loan.
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We’ll start with a brief questionnaire to better understand the unique needs of your business.
Once we uncover your personalized matches, our team will consult you on the process moving forward.
1. Build personal and business credit scores
Personal credit scores indicate your ability to repay personal debts, such as credit cards, car loans and a mortgage. Small-business lenders require a personal credit score because they want to see how you manage debt.FICO scores, commonly used in lending decisions, range from 300 to 850 (the higher, the better). You can get a free credit score on NerdWallet and a free copy of your credit reports at AnnualCreditReport.com.Fast ways to improve your personal credit include disputing any inaccuracies in your report and paying bills on time and in full.More-established companies will have business credit scores (which generally range from 0 or 1 to 100) with credit bureaus such as Experian, Equifax and Dun & Bradstreet. Steps to building business credit include establishing trade lines and keeping public records clean.You’ll likely need excellent business credit and good personal credit to qualify for a government-backed SBA loan or traditional bank small-business loan. Online lenders may be more lenient with credit scores, emphasizing your business’s cash flow and track record instead.
2. Know the lender’s minimum qualifications and requirements
You’ll typically need to meet minimum criteria around credit scores, annual revenue and years in business to qualify for a business loan, though some lenders may be flexible if you underperform in one area but overperform in another.Qualifications can also vary by the type of business loan you want. For example:
- For loans backed by the U.S. Small Business Administration: Your business must meet the SBA’s definition of a “small” business, operate as a for-profit company and can’t be an ineligible business, like life insurance companies and financial businesses such as banks. You must also be current on all government loans with no past defaults — you’ll be disqualified if you’ve been late on a federal student loan or government-backed mortgage, for instance.
- For bank and online business loans. Banks and online lenders typically underwrite loans based on traditional factors, but online loans carry less stringent requirements. For example, some online lenders offer bad credit business loans or may approve companies that haven’t been in business as long. On the downside, this ease of qualification typically comes with a more expensive loan.
3. Gather financial and legal documents
Banks and other traditional lenders typically require a wide range of paperwork when you apply for a small-business loan. The financial and legal documents you may need for a small-business loan include:
- Personal and business income tax returns.
- Balance sheet and income statement.
- Personal and business bank statements.
- A photo of your driver’s license.
- Commercial leases.
- Business licenses.
- Articles of incorporation.
- A resume that shows relevant management or business experience.
- Financial projections if you have a limited operating history.
Online lenders may provide a streamlined application process with fewer documents and faster underwriting. If you have good credit and strong business finances, some online lenders may offer you rates comparable to bank loans.When getting a business loan, be sure to compare options to find the lowest cost loan that fits your company’s needs.
4. Develop a strong business plan
Lenders will want to know how you plan to use the money and see that you have a strong ability to repay. They may require a solid business plan that details the purpose of the loan and how you expect it to increase profits.You business plan should also include the following:
- Company description.
- Product and/or service description.
- Management team.
- Industry analysis.
- Facilities and operations plan.
- Current and projected financials.
- Promotional, marketing and sales strategy.
- SWOT analysis (strengths, weaknesses, opportunities, threats).
Your business plan should clearly demonstrate that you will have enough cash flow to cover ongoing business expenses and the new loan payments. This can give the lender more confidence in your business, increasing your chances at loan approval.Use NerdWallet’s business loan calculator to estimate your monthly loan payments:
Calculate estimated payments, then see if you qualify for a business loanLoan amount$Loan term (months)Annual percentage rate (APR)1%Not sure? See estimate rates on online business loans and SBA loans.
5. Provide collateral
To qualify for a small-business loan, you may have to provide collateral to back the loan. Business collateral is an asset, such as equipment, real estate or inventory, that can be seized and sold by the lender if you can’t make your payments. It’s a way lenders can recover their money if your business fails.For example, SBA 7(a) loans above $25,000 require collateral, plus a personal guarantee from every owner of 20% or more of the business. A personal guarantee puts your credit score and your personal assets on the hook.Some online lenders do not require collateral but may want a personal guarantee. Others may also take a blanket lien on your business assets — essentially another form of collateral — giving the lender the right to take business assets (real estate, inventory, equipment) to recoup an unpaid loan. Each lender has its own rules, so ask questions if you’re unsure what’s required.If you don’t have collateral to get a loan or don’t want to take on the risk of losing personal or business assets, unsecured business loans may be a better option.
In other words, Joanie’s Pet Sitting is not the same as Joanie’s Pet Sitting LLC. Joanie’s Pet Sitting, Virginia Beach is not the same as Joanie’s Pet Sitting, Norfolk.
If a business name, address, or phone number changes, the change should be made on every license and document related to the business. You can’t rewrite former financial records. But you can include documentation that supports the business history. You can include a letter of explanation as well.
The main concern of a lender is to determine your ability to repay the loan. Here’s a look at the key pieces of the loan application puzzle.
Top 8 Small Business Loan Requirements
Here are the top 8 small business loan requirements and how to qualify for a loan:
Personal Credit Score
Your personal credit score carries a lot of weight in the business loan application process. For many types of business loans, when you as the owner of the business sign on the dotted line, you are guaranteeing payment of the loan.
This is especially true with fledgling small businesses that are still building a history of tax returns. Don’t worry if your business is relatively new. You may still get a loan if you have an excellent personal credit score and all the business owners have good credit scores. If your business has multiple owners, the lender may want to see a credit score from each. The loan amount will be closely tied to those scores.
Some lenders may require the business to be operational for a minimum of 2 years. If the business has 2 or more years behind it, lenders may look at a business credit score. That score comes from a business credit bureau, such as Dun & Bradstreet.
Action to take: Before applying, business owners should check their personal credit score to make sure all the information is correct. Get credit scores from each owner. Clear up any inaccuracies. Some credit report monitoring services have suggestions for improving your score, and you may be able to bump your score up a bit if you have time. In borderline cases, it could be enough to net you a better interest rate or other terms.
Work to improve your credit score. Schedule payments to make sure you make them on time, reduce your debt, open a business credit card and keep you utilization of available credit low.
Bank Statements and Ratings
What do lenders look for when they examine your bank records? Lenders look at seasonal fluctuations in income, debt to income ratio (see below), and tax obligations.
When you’re borrowing from a bank, the bank will assign a rating. The rating is the total amount of borrowing capacity you have from that bank.
The date you opened a business bank account is used as the start date for your business. The longer your business has been established, the more likely you are to qualify for a loan.
There are contributing factors to favorable bank ratings. Ideally, your average daily balance should be above $10,000 for 3 months. Manage your bank accounts to keep the average daily balance as high as possible. Avoid overdrawing your account, and set up overdraft protection.
It’s not enough to just have the money sitting there. Your business should be generating a steady volume of regular deposits.
You also should have a bank reference, who is the person you work with at the bank. In other words, a person who will vouch for you as bank officials consider your loan.
Revenue/Balance Sheet
Of course, revenue is important. A business must make money to stay afloat, and pay the requested loan.
But revenue is just one of the important numbers that help businesses get loans. Revenue is part of a balance sheet.
The balance sheet includes assets, liability and owner equity. The assets of businesses are subtracted from the liabilities of businesses. The calculated amount of owner equity is added to that number. That number is an estimate of what the business is worth. That number must be reasonable in comparison to the loan amount sought.
Action to take: Chip away at the amount of liability every chance you get. It’s a lot like paying off a credit card. Just paying interest keeps you treading water. Applying even a small amount of money monthly to principal debt will show a positive change and attention to the health of the business.
Debt-to-Income Ratio / Cash Flow
Think of the balance sheet as a snapshot of your business. The debt-to-income ratio, or cash flow, is a monthly snapshot.
Each month, after expenses are paid, how much money is left? This number shows the lender how much of a loan payment you may be able to handle monthly
Lenders may also do a comparison of accounts receivable to accounts payable. You won’t be able to “pick your best month” as an example. The lender will do that comparison the month you are asking for a business loan.
What’s the number that a lender wants to see for a debt service coverage ratio? A lender typically wants to arrive at a calculation that is less than 1.25 or 1.35 times your expenses. That calculation of expenses will include the payments you’d be making on the loan you are seeking.
How does the lender get to that debt service coverage ratio number? Typically, the lender divides the annual net operating income by the total principal and interest of all debt obligations.
Here are the highlights of what a lender will analyze: gross margin, cash flow, debt to equity ratio, accounts payable, accounts receivable and earnings (before interest, taxes, depreciation and amortization).
Lenders prefer to see financial statements that have been audited by a certified public accountant. You can have financials reviewed by a CPA – which is faster and cheaper – but some lenders require audited financials. Find out what the lender requires.
Action to take: Accounts receivable will only include goods or services that have already been invoiced. Make sure you are invoicing promptly. And of course, make sure you are paying your bills promptly. Proving that you are up to date with sending out bills and paying bills shows the lender that you have a good process in place for money management.
2+ Years in Business
For a Small Business Administration lump-sum loan, your business has to have been running for 2 years. There are SBA loans that don’t have that requirement, such as many of the line-of-credit loans and the SBA microloans.
To get a business loan from the SBA, you’ll need to present tax returns for the past two years that prove the existence of the business.
Action to take: Organize your tax returns. Put them on a disc or into another format that is easy to provide to a lender. Provide a business credit report. Provide the applicant’s credit report and get copies of the credit scores of all owners.
Type of Industry
To get an SBA loan, businesses must meet the requirements according to the SBA’s definitions of small business. Those definitions vary by type of industry.
The SBA definition of small business is two-part: by the number of employees or by the average annual receipts (gross income).
The gross income is averaged over 3 to 5 years. If the business hasn’t been around for more than a year, the gross income is calculated by the average weekly income times 52.
The number of employees is calculated as the average number of employees per pay period. This includes part-time employees. The average is calculated using a 12-month period.
For a look at the SBA requirements under the type of industry, go to www.sba.gov/document/support–table-size-standards. It’s an interesting read and may make you realize just how big or small some small businesses are.
For example, a cheese manufacturer can have up to 1,250 employees, and be considered, well, small cheese. A flower or nursery stock wholesaler may have no more than 100 employees.
Businesses can make a lot of money and still be considered small. For example, a home health company can have yearly revenue of up to $16.5 million. A baked goods store can make up to $8 million.
Action to take: If you think your business is too big for a small business loan, think again. Check the Type of Industry chart to learn the requirements. You may be pleasantly surprised to find out you can apply for a small business loan. Get familiar with the numbers for employees by the type of business. Since part-timers are also counted, you might be getting close to going over the requirements. To qualify for an SBA loan – with better rates and longer payback terms – you may consider combining part-time positions to full time.
Collateral or Assets
Not all lenders require that you put up collateral to get a loan for business use. But for those lenders that do, you may have to list assets on your loan application.
Lenders like to see assets that they can easily use (seize) if needed to cover your loan obligation if you fail to repay.
Assets include business real estate, inventory and business equipment. It’s important to know that collateral can also include funds from accounts receivable. That can include monies that have been invoiced but haven’t yet been paid to the business.
If you can’t pay the loan, the lender can seize the assets. For real estate and equipment loans, a UCC (Uniform Commercial Code) statement may be filed to claim accounts receivable and other collateral.
If you don’t have sufficient assets, a lender may require personal guarantees. This is not a good option. This type of loan backing puts your personal assets at risk as well as the assets of the company.
Action to take: Yikes! Imagining a future where you lose business real estate and inventory may give you pause as you list those items on your loan application. Scary stuff. But it’s a given that those who are confident enough to start and operate a business have already demonstrated determination and boldness. Taking out a business loan is a risk, but growth doesn’t come without risk.
Business Plan
Lenders don’t often ask to see a business plan from those seeking loans for businesses. But adding information about the plan to your application may make your business stand out from others looking for a loan.
It’s like adding a brilliant cover letter to your resume. Of course, the application information includes bank statements, information about the owner’s (or owners’) credit score.
You may also include information about the nuts and bolts of your company. Let the lender know what you do and how you make money.
Also, include information about how the loan fits into your plans for the business. Let the lender know how you place the spend the proceeds of the loan. Provide realistic financial projections for future growth
If applicable, include market information and details on the status of your business niche. Describe how demand for your products and services is growing. Make projections to predict future growth.
Action to take: As you prepare to apply for the business loan, gather the paperwork needed to document your business plan. Include bank statements, information about personal credit/credit score and business expenses. These are the black and white proof of your ability on paper to pay the loan.
Add the missing piece to make your application for a business loan stand out from others. The average person on a lender review team may have no knowledge of what your business is.
For example, let’s use a business that makes something called a Skid Plate. Piece of metal that goes under a car, huh? Would a lender want to grant a business loan for a company expansion? What if the lender knew that the Skid Plate was a patented new product, in huge demand in the race car industry, primarily NASCAR?
By adding an explanatory description of the business, you will be more likely to get a business loan.
Who Can Apply for a Small Business Loan?
Any small business can apply for a loan. You should be making a profit and have a good credit score. You should not be involved in any default action by any entity, including the US government. People in the loan business don’t like that kind of stuff.
If the business owner is going for a loan through the SBA, the requirements are different. The SBA requires that your business operates within the United States and has been operating for a minimum of 2 years. If you can’t meet those qualifications, don’t bother going through the application process.
Are Small Business Loans Hard to Get?
The business loans are not hard to get if the company has owners with good personal credit and has been making money.
If you or any of the company owners (20% ownership or more) have a bad credit score, you have little chance of getting loans through the SBA. The SBA won’t give loans to a businesses which aren’t making money. A startup entity may try for a microloan.
You may find although you were stressed out about how to land a business loan, the process was easy. If you’re already running a company, you’re good with paperwork. Or you’ve hired somebody who’s good with paperwork!
One of the main requirements for getting loans is being organized. Get your paperwork stuff together and go for it. Today you have more options than ever for getting business loans.
For more information see the Small Business Credit Survey1.
What Documentation Must I Provide?
Lenders require documentation for business loans and it varies by the type of loan. At a minimum, you will need to provide income tax returns, your credit score, bank account information, a business financial statement, and personal identification such as a driver’s license. For more information about loan paperwork, go to Business Loan Documents to Provide.
What is the Minimum Credit Score for a Small Business Loan?
Most lenders require a minimum credit score of 600-680 for a small business loan. That’s a minimum requirement for business loans from most lenders.
People who get a business loan from an online lender may be able to get around that qualification. Online lenders considering loans often value business revenue more highly. Do some shopping, as the loan amount is typically smaller with varying interest rates.
How Much Can I Borrow on a Business Loan?
The amount of money lenders award is directly connected to how much you can afford. It won’t be how much you think you can afford. It will be how much the lender determines you can afford.
That’s a good thing. A reputable lender has your back and doesn’t want you to fail.
Conclusion
There are quite a few people out there who want to start a small business and have come to the conclusion that a small business loan is the way to go. Granted, you have to keep in mind the advantages and disadvantages of taking on a small business loan, but it’s worth it if you’re looking for the extra funds to help your business grow and move forward.
A small business loan, or a line of credit can be an excellent way to build your business, especially if you’re starting a new business. Often times, it’s not even necessary to have collateral to get approved for a small business loan.