Definitive Guide for Qualifying for a Small Business Loan

When the owner of a company applies for a small business loan, rather than applying for a personal loan, banks or alternate lenders apply a greater amount of scrutiny during the approval process.

Qualifying for a small business loan requires more criteria than applying for a personal loan would, because of the greater risk the financing process would pose to the lender. The application process might take more time, with more documentation required, more paperwork, and a wider range of financial details taken into account.

Before this caveat becomes too intimidating for the small business owner reading this, the more stringent business loan requirements for eligibility should not scare off an entrepreneur from applying for financing. Doing so might mean the difference between one's business surviving and eventually thriving or falling apart altogether.

What defines a small business anyways?

According to the Small Business Administration (SBA), “a small business is defined ‘either in terms of the average number of employees over the past 12 months, or average annual receipts over the past three years.' Also, all federal agencies use SBA's size standards, and therefore it's important to determine your NACIS code.”

The SBA criteria for a small business in the United States is one that:

• Is organized for profit
• Has its place of business in the U.S
• Operates primarily within the U.S. or makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor
• Is independently owned and operated
• Is not dominant in its field on a national basis

The business may be a sole proprietorship, partnership, corporation, or any other legal form. Generally, a small business, according to the SBA definition, has less than 500 employees and may have revenues under about $10 million (depending on the industry). Now those can be some big small businesses when you think about it in those terms, but the SBA definition is used by many lenders when considering how to classify their business clients and what services they are willing to provide them.

So, read on to learn about some of the essential criteria for qualifying for a loan when you run a small business.

Criteria for Getting a Small Business Loan

Your credit scores

Most banks or lenders will look for a personal credit score of at least 620 as a baseline for prospective approval. The credit score is determined by FICO, a data analytics company that's been around for nearly 70 years. Occasionally, a bank might incur the risk of financing an applicant with a score under 620 if the company doesn't have any bad credit or other red flags in its financial history. On the other hand, some banks will want to see a credit score close to 700 before they consider approving a bank loan. The higher one's credit score, the more money you’ll qualify for receiving as a loan.

There’s also a business credit score to consider if you’re a small business owner applying for a loan. Many lenders will work with a third-party agency to determine if a business pays its bills on time, has too many accounts payable or receivable outstanding, and if they have any other credit facilities that may have been reported to credit bureaus.

The length of time the business has existed

Most traditional lenders will only accept applications from small businesses that have been operating for a minimum of two years. Occasionally, there might be cases where a lender will give the nod to a company that's younger than this, but usually only if there is a strong personal guarantee on the loan, a third-party guarantor, or even a whole other business that can be used as collateral for the loan. Basically, a good thing to keep in mind is that the less time you've been in business, the more of a longshot your loan becomes.

Monthly revenue

Most business loans require consistently high annual revenue. In general, having monthly revenue of $10,000 is a good threshold for most small businesses to qualify for some kind of financing. Typically, a lender will provide approximately one to two months’ worth of revenue as financing for the business, depending on other factors. This is a very important factor for business owners to understand. Small companies that have been in business for less time may not have established a consistent average monthly revenue to include on their loan application. Business owners should check that they have enough business history to show their monthly income via financial statements from at least a half-a-year, or for the full time the business has been in operation.

The purpose of the loan

The lender is going to want to know why your company needs to borrow money, and what the money is going to be used for. How much financing your business will qualify for and the types of business loans available depends a lot on the answer to this question.

Personal debt to income

Too much personal debt serves as a red flag to many traditional lenders and could be a deal-breaker for the small business seeking financing. Too many debts from personal credit could indicate that a business owner is over-leveraged and that they will not be able to fall back on that personal credit in the absence of cash flow from their small business. A personal guarantee, another instrument often used in business lending, would not be as valuable to the lender in these cases, so they will often decline to fund that business.

For many business owners, this is a double-whammy, considering the personal credit score requirements that are already in place. The largest percentage of one's personal credit score is based on 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 FICO score. Length of credit history, type of credit used, and amount of new credit inquiries account for about 35% of the criteria.

Luckily, there are alternative funding sources that consider business performance over and above the personal income or debts of the business owner, but nevertheless, it is still important to consider personal credit factors such as these before you apply for financing, no matter where you choose to go.

What documents will you need?

No one ever said applying for a loan is fun. No matter how much optimism you might have for the long-term future of your small company, the business loan application process can be a cumbersome task, especially when it comes to rounding up the number of documents you’ll need to present to the lender.

Those documents include:

1. Credit report

Applicants are entitled to a free credit report once a year from each of the three major consumer reporting companies: Equifax, TransUnion, and Experian. You can request a copy from AnnualCreditReport.com.

A free credit report may be obtained either online at annualcreditreport.com, by phone at (877) 322-8228, or by mail by downloading a form from this link Annual Credit Report Request form and then sending the completed form to:

Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281

2. 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.

3. Personal and business tax returns

Again, this will vary from lender to lender, but in general, lenders want to see some history of paying the tax-man his due over the time the business has been in operation. Tax liens are one of the most problematic obstacles for business owners to overcome and showing a lender that you are filing fully and on time will help them understand that this is not a concern for your business.

4. Income statement

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

5. 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.

6. Cash flow statement

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

7. 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.

Types of Small Business Financing to Consider

Which financing options should a small business owner seek for his or her company?

Some types of small business financing include:

SBA Loan

The U.S. Small Business Administration (SBA) offers commercial financing backed by the SBA through its SBA 7(a) loan program. The most common type of SBA loan, an SBA 7(a) loan assists businesses in the purchasing or refinancing of 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 suited to assist businesses that are unable to secure credit anywhere else. With an SBA (7a) loan, the borrower can purchase land or buildings, build on new property, 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 that are used for commercial real estate may be as long as 25 years for repayment. Each monthly loan payment would be the same until the loan is fully repaid.

Merchant Cash Advance

Another way to facilitate access to money needed to finance one’s business expenses is a merchant cash advance. In this instance, 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 for a business owner to get his hands on capital when the business’ need for cash becomes extremely pressing. A business owner might be slammed with a bill he or she did not expect, or the owner might need the cash fast in order to consummate a time-sensitive deal that must be decided upon sooner rather than later.

With a merchant cash advance, a business owner can potentially get hold of a large sum of funding in a hurry. The turnaround actually could be realized in as little as 24 to 48 hours in some cases. A merchant cash advance could be for a sum of a few thousand dollars up to as much as $200,000 with a minimum of paperwork.

A 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 loan. This type of loan must be repaid with interest in a period of one to five years. If your credit is good enough 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 have eligibility for 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 an increasingly 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.

Invoice Factoring

For companies that have unpaid invoices, invoice factoring is a financing method where you sell your accounts receivable at a discount for a lump sum cash amount.

A method of securing working capital that is a little different than applying for a loan, invoice factoring is 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 the business owner’s invoice, the factoring company collects payments from the business’ customers over a span of between one and 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 problem of cash on hand.

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. In addition to fast approval, other advantages of short-term online loans for working capital include paying less interest, the chance to improve a bad credit rating, and flexibility.

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 this line of credit, funds can be accessed whenever they are needed until the established credit limit has been reached, similar to a 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 credit score of 500 to qualify for a business line of credit.

Short-Term Loan

A loan with a fairly short 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 pretty 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 come with 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 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.

Getting qualified for a small business loan

Now that you know more about how small businesses can qualify to receive financing, it’s time to size up your business’s options. You may want to start by finding a funding provider that will help you get the best small business loans that are actually fit for your business needs. Look for funding companies that can provide a range of product offerings, and definitely evaluate their online reviews and other customer feedback before you start to apply. When you’re ready, you can often get a prequalified status by visiting the company’s website and filling out an application. Then, prepare your materials and work with the lender to get your application through the process so you can get back to your work knowing that you have the knowledge needed to qualify for that important loan.

FAQs

How to get a small business loan?

If you are looking for small business loans, you need to keep track of the following things,

• Eligibility: You must have a registered business with a purpose for which you can repay the loan.
• Credit history: A decent credit score and history.
• Business plan: You should have a well-prepared business plan with the financial attributes that help the lender understand your repayability.
• Documentation: You must provide your legal and financial documents, like tax returns, business plans, and bank statements.

How to apply for a small business loan?

To apply for a small business loan, you can:

• Use the SBA's Lender Match tool: Enter the essential information for the loan you want and create an account to connect with participating lenders. You can then apply instantly through the lender that selects you.
• Apply online: Some lenders let you know online, which can be quick and automated.
• Apply in person: Traditional banks can ask you to visit their physical branch to apply. 

How to get a small business loan with bad credit?

For small business owners with bad credit, alternative lenders like online platforms, merchant cash advance providers, invoice factoring companies, and the SBA microloan program can be viable options. These lenders often have more flexible credit requirements but may come with higher interest rates and fees. To increase your chances of approval, focus on building your business credit by applying for business credit cards and making timely payments.

What makes you eligible for a small business loan?

There are several factors that decide your small business loans:

• Credit score: Lenders usually want a personal credit score of 670 or more, but the minimum score varies by lender and type of loan.
• Time in business: Lenders usually see how long the company has been in the industry.
• Debt service coverage ratio (DSCR): Lenders want a DSCR of at least 1.25, which shows the business has enough cash flow to cover its debt obligations.
• Collateral: Lenders may ask you for collateral, like real estate, equipment, or cash, to reduce risk. The lender can repossess the collateral if you cannot repay the loan. 

What credit score is needed for a small business loan?

If it's a small business loan, then your credit depends upon the lender and the type of loan you have opted for. Although, a credit score of 680 or above is usually considered good. Moreover, a credit score above 720 is supposed to be excellent and can give you access to the best terms and interest rates.

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