small business loan requirements guide

To keep the engine of a small business running, it often becomes necessary to seek financing so that bills and employees can be paid without interruption. When a small business loan is needed to help a company run its operations or make a large purchase, it helps if a business owner is ready to meet the requirements that go along with their loan application.

While many business owners would rather avoid the specter of burdensome business debt, it can become a necessary evil if the alternative is the inability to pay monthly bills, risking, at best, a damaged credit score and, at worst, the loss of the company.

There are plenty of different types of small business financing available for the owners of small companies to avoid these worst-case scenarios, but before you make the decision to seek financing in order to accelerate cash flow, it’s important to undertake a self-evaluation of your business to make sure you meet the eligibility requirements for any of the different small business loans offered by banks or other lenders.

Below are some of the variables that will impact whether a small business meets the qualifications for loan approval.

Qualifying for Business Loan Approval

1. Credit Scores

Being saddled with a poor personal credit score can damage the chances of receiving financing approval. An applicant with a favorable personal credit score can boost his or her chances not only of getting approved, but also obtaining a loan at a lower interest rate.

The threshold for what qualifies as a “good” or “bad” credit score? FICO, a widely employed model of scoring one’s credit, assigns credit scores of between 300 and 850. If you want to be assured of getting approved for a small business loan, you’re in safe territory if your score exceeds 670. A score below 580 is something to be concerned about.

You could receive loan approval with a credit score as low as 500 from certain online lenders, but traditional lending agents, such as banks, will usually have higher standards for signing off on bank loans to a small business owner. However, if you have a low credit score, you are considered a greater risk to pay back. Borrowers pay a premium for the risk that lenders are taking when providing money to someone whose credit is less than stellar. As the old adage goes: high risk, high reward.

The higher one’s credit score, the more money you’ll qualify for from lenders.

Too much personal debt serves as a red flag to a lender and could be a deal-breaker for the small business seeking financing. Too many debts from personal credit could indicate that you’ll fall back on that personal credit in the absence of cash flow from your company. The largest percentage of one’s personal credit score is based on their payment history. How much debt the applicant owes is the second-most important factor. These two criteria account for about 65% of one’s personal credit score. Length of credit history, type of credit used, and amount of new credit inquiries account for about 35% of the criteria.

2. Cash flow and income

Most business lenders require a certain level of annual revenue. After all, a lender’s main concern is whether the borrower will be able to pay back their loan. Companies that have low revenue levels and significant periods of poor cash flow will find it challenging to secure financing.

3. Age of business

Firms that have been operating for shorter periods of time often have a hard time obtaining funding simply because they have not been in business long enough to show an established track record of payments. It can be challenging for companies younger than a year to prove they have an adequate flow of capital that would enable them to pay back money that they borrow.

Most lenders will only accept applications from small businesses that have been operating for a minimum of between six months and a year. Occasionally, there might be cases where a lender will give the nod to a company that’s younger than six months, but the less time you’ve been in business, the more of a long shot your loan becomes.

4. Current amount of debt

Some lenders will review your debt-to-income (DTI) ratio so that they know whether you are able to incur more debt by seeking additional financing. Your DTI ratio weighs your monthly debt against your gross income.

How is DTI determined? Divide your monthly debt by your gross income. For example, if your monthly debt is $10,000 and the gross income is $20,000, your DTI ratio is 50% ($10,000/$20,000).

The higher your DTI ratio, the more of a risk you represent to a lender. If you can keep your DTI ratio at or below 43%, it should enhance your chances of qualifying for a loan.

5. Collateral

Lenders may demand collateral as a prerequisite for approving a loan request. Small business owners can expect to be asked to put up invoices, accounts receivable, equipment or real estate as collateral, which refers to personal assets that the owner of the company already possesses. Not all business loans require collateral, some require a personal guarantee, however. Collateral basically provides assets of value that can be obtained – and likely sold off – if a borrower defaults on a loan.

6. Industry

The category of industry can impact the probability of qualifying for financing. Some industries are considered to either pose a greater risk to the lender, or are less reputable and carry a more negative stigma than others. An estimated 50% of restaurants fail within the first two years. Thus, it is considered a riskier type of business. Aspiring restaurateurs often discover that obtaining financial backing for their venture can be the most difficult part of the venture.

Seasonal businesses could also hinder the likelihood of loan approval because the lender might view their seasonal nature as posing a risk to the company’s cash flow. Landscapers, amusement parks, ice cream shops, and companies buoyed by summer resort areas are examples of seasonal businesses whose off-seasons might loom ominously. Lenders typically are wary of companies that have extended periods when cash flow is slow or even non-existent. A lender might eye such businesses with more skepticism in terms of their risk.

Have a Business Plan

Another thing that it would be wise to have at the ready for a potentially demanding lender is a business plan. Most business plans fall into one of two common categories: traditional or lean startup.

Writing a traditional business plan with a standard structure entails going into considerable detail in each section of the document. A traditional business plan is a lot of work, because of the elaboration involved.

A lean business plan, on the other hand, outlines the most vital components of the plan in a much more streamlined format that might only take up a single page.

The advantages of creating a lean business plan include an immediate emphasis on what drives your company’s strategy and its intended success, the development of something that a reader without a deep background in business can still comprehend, giving a visual presentation of the business model you’re creating, creating something flexible enough to easily update, and saving time—which is what a long-form business plan consumes much more of.

Financial Documentation

In addition to having a solid business plan and credit report provided by credit bureaus, entrepreneurs should have ready the following financial documents that are typically required in the loan application process.

1. Business bank statements

At least six months of business bank statements will be required for most business financing applications. Some lenders may go the extra mile and ask applicants to also provide personal financial statements or bank statements from their bank account.

2. Personal and business tax returns

Again, this will vary from lender to lender, but in general, lenders want to see some history of paying your taxes over the time the business has been in operation. Exhibiting to a lender that you are filing fully and on time will help them understand that this is not a concern for your business.

3. Income statements.

Profit-and-loss statement displays revenues and expenses for an accounting period and indicates whether a business is making a profit.

4. Balance sheet

In contrast to an income statement, a balance sheet lists the assets and liabilities of a company and the owners’ equity. Assets are what you own; Liabilities are what you owe.

5. Cash flow statement

This type of statement indicates the amount of cash entering and leaving your business in a given period. A properly prepared cash flow statement will exhibit how much cash a company has on hand for a specific period of time.

Types of Small Business Financing to Consider

Which financing options should a small business owner seek for his or her company? The requirements may vary depending on the type of financing that you choose.

Some types of small business financing include:

1. SBA Loan

The U.S. Small Business Administration (SBA) offers commercial financing backed by the SBA, SBA Loan programs include SBA 7(a) loans, 504 loans and microloans. A 7(a) loan, The most common type of SBA loan, helps companies to buy or refinance owner-occupied commercial properties up to $5 million. This loan also gives the business owner a chance to borrow working capital loans.

These loans are ideal for helping businesses that might encounter problems trying to get financing elsewhere. With an SBA (7a) loan, a business owner can buy land or buildings, build new or renovate existing property, as long as the real estate will be occupied by the owner. Through an SBA (7a) loan, an entrepreneur can borrow up to $5 million through an SBA lender. The maximum allowed interest rates for the program are based on the Wall Street Journal Prime Rate plus a margin of a few percentage points. Interest rates can be fixed, variable, or a combination of the two. Loan terms for 7(a) loans used for commercial real estate may be as long as 25 years for repayment. Each monthly payment would be the same until the loan is fully repaid.

2. Merchant Cash Advance

Another avenue to financing one’s business expenses is a merchant cash advance. This is when a company grants the borrower access to cash. The borrower is then required to pay a portion of his or her sales made with credit and debit cards, as well as an additional fee.

A merchant cash advance does not require collateral or a minimum credit score. However, merchant cash advances to business owners involve higher costs than most other forms of borrowing.

A merchant cash advance is an expedient way to obtain capital when the need for cash is extremely pressing. A business owner might be slammed with a bill he or she did not expect or might need the cash fast in order to consummate a time-sensitive deal.

With a merchant cash advance, a business owner can potentially get hold of a large sum of funding in a hurry. The turnaround could be consummated in as little as 24 to 48 hours. A merchant cash advance could be for as little as $1,000 or as much as $200,000 with a minimum of paperwork.

3. P2P Loan

Business owners with good FICO scores who need a small amount of working capital quickly may be able to meet small, short-term working capital needs with a peer-to-peer, aka P2P, loan. This type of business loan must be repaid with interest in a period of one to five years. If you have enough good credit to command better rates than you’d get with a short-term loan online but is not quite good enough to qualify for an SBA loan, you might consider a peer-to-peer loan.

Peer-to-peer personal loans are offered directly to individuals without the intermediation of a bank or traditional financial institution. Online lending platforms fund borrowers via institutional lending partners. Also referred to as marketplace lending, peer-to-peer (P2P) lending is a popular alternative to traditional lending. Borrowers and lenders can both benefit from this more-direct lending system.

In P2P lending, one party lends money to a business, with the promise of receiving a sizable return for doing so.

4. Invoice Factoring

Small businesses that are holding on to unpaid invoices could employ invoice factoring, the process of selling invoices at a discounted rate to a factoring company and receiving in return a lump sum of cash that can be used as working capital.

After assessing the risk of financing a business owner’s invoices, the factoring company collects payments from the business’ customers over a span of one to three months. If a company sells something to a customer, but that customer cannot pay off the invoice right away, there’s a gap of time that could create a shortfall for the business owner. The lump sum that the business would receive by undertaking the process of invoice factoring would cover the shortfall and solve the cash flow problem.

5. Online Loan

Short-term loans from online lenders may be easier to get approval for than some other types of loans.

Choosing to apply for a short-term loan comes with the expectation that you might have to repay it over just a couple of weeks. If you have an installment loan, you have up to six months to pay it off. A short-term loan application is completed online and normally takes a matter of minutes to be approved.

Rapid processing is one of the main attractions of a short-term online loan. Sometimes loan approval could even come the same day the application is placed. Other advantages of short-term online loans for working capital include paying less interest, the chance to improve a bad credit rating, and flexibility.

6. Business Line of Credit

When a lender provides a pre-approved loan amount with a maximum credit limit, that is known as a business line of credit. If the borrower is approved for a line, funds can be accessed whenever they are needed until the established credit limit has been reached. (This is similar to a business credit card.) Because the borrower is only paying interest on the amount that he or she withdraws, a business line of credit can be advantageous for business owners who are uncertain of the amount of funding they will actually require, or when they might need it.

The drawback to a business line of credit is that the loan will be at a rate that might be considerably higher than other types of loans. How costly that would be is heavily dependent on the amount of funds the entrepreneur ends up using.

Sometimes a business line of credit can be approved in as little as 24 hours or less. Depending on the lender, you might only need a business credit score of 500 to qualify for a business line of credit.

7. Short-Term Loans

A loan with a relatively brief repayment period, a short-term loan is one in which the borrower receives his cash in a lump sum upfront, then repays the loan, often with some fairly sizable financing rates. Some short-term loans allow the borrower to make extra payments to pay it off sooner. However, some short-term loans actually carry penalties for early repayment. Short-term loan options generally have a term of 12 months or less. Payments on short-term loans are required frequently — sometimes once a week, or, in some cases, every day.

Although the business credit requirements are not as strict for short-term loans as they are for regular term loans, the frequent loan payment schedule may be burdensome for someone in a new business without a lot of cash flow at that moment. But a businessperson who needs a loan in a hurry still might opt for a short-term loan because it may be easier to secure than other forms of financing.

What’s Next After Meeting the Small Business Loan Requirements?

Now that you know more about how small businesses meet the eligibility requirements to get a loan, you may want to locate a funding provider that will help you get the best small business loans for business needs. Seek out lenders that can provide a range of offerings and evaluate their online reviews and other customer feedback before you apply. You can often get a prequalified status by going to the company’s website and filling out an business loan application.

After that, get all your materials ready to bring to the lender so you can find out what you need to qualify for financing.

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