For small business lenders, whether or not a loan application is approved boils down to basic numbers.
Basically, the debt-to-income ratio for your small business. In other words, how much of your small business’s monthly earnings are used to repay existing debt.
As a small business owner, you need the documentation to prove your worth and meet the loan requirements. Here’s a guide to the standard requirements businesses must meet as you learn how to get a small business loan.
Understanding Small Business Loan Requirements
Here’s a list of information that your lender will want to see:
- business and personal credit score
- annual revenue
- number of years in business
- business industry and size
- business plan and loan proposal (what you want to do with the money)
- collateral or a personal guarantee
- other business financial documentation, including a list of business assets
Why Lenders Have Specific Requirements for Small Business Loans
Why do lenders consider a personal credit score part of borrower qualification? The lender wants to see how you manage your personal debt. That’s an indication of your money management skills.
What about risk management? For a lender, various types of small businesses have different risk levels. For example, restaurants and beauty shops have a higher risk level than other types of businesses.
That’s because those two types of industries have a higher failure rate than other businesses.
Top Tips for Meeting Small Business Loan Requirements
You can secure financing by taking steps to make your application the best it can be.
Here are some tips and strategies:
Improving Your Business Credit Score
Good financial habits boost your credit score. These good habits are practices such as paying down debt, including credit cards. Also, pay bills not only on time but in full when due.
If you’ve done that and still haven’t reached the credit score number you want, it’s time to take a deeper look into the report. There may be some long-ago unpaid bill that is crushing your number – even something as simple as an old electric bill from a previous address. Look into your report and dispute/clear up any inaccuracies.
Preparing Thorough Financial Documentation
Thorough documentation is important, of course. How you present, it is just as important.
For example, present all the paperwork required as a package. Don’t make the lender shift through a series of emails with attachments you’ve sent. You’re not the only applicant the loan manager is considering – make the process as easy as you can for that person.
Types of Small Business Loans and Their Requirements
There are three basic types of lenders:
The Small Business Administration (SBA) – Learning how to get an SBA loan is often easier for small businesses than working with other lenders. You’ll need a very good credit score (690 or higher), but you’ll get a good interest rate and long SBA pay-off terms. You must meet the definition of a small business, which varies by industry. You must be current on all existing business loans and no defaults.
SBA loans are obtained through SBA-approved banks. The SBA also has start-up loans and microloans (the borrowed amount is less than $50,000).
Traditional Lenders – Traditional lenders are banks and credit unions. The typical loan requirement is an annual revenue of $250,000, a credit score of 690 or higher, and at least a two-year business history. Learn how to get a business loan from a bank here.
Alternative Lenders – Alternative lenders include online lenders, fintech companies, and those providing short-term loan options. The average loan requirement is an annual revenue of $100,000, six months in business, and a minimum credit score of 500.
Essential Small Business Loan Requirements
Let’s break down the common small business loan requirements.
A Good Business Credit Score
A good business credit score is the basic requirement. You’ll need a minimum score of 500 to apply for a loan with an alternative or online lender. Lenders rely on your business credit score as an indicator of eligibility. With a poor credit score, an applicant is considered high risk.
Financial Statements
There are a number of loan documents you’ll be asked to provide:
- personal and business tax return
- personal and business bank statements
- business profit and loss statements
- balance sheets
- income statements showing cash flow
- commercial leases
- the business license
- articles of incorporation (if applicable)
- proof of collateral
- information about existing debts
- legal contracts
- your business plan (including financial projections).
Collateral and Personal Guarantees
Examples of collateral from your business would be equipment, real estate and inventory.
A personal guarantee means you agree to raise money from personal assets. A personal guarantee means that you’ll pay the loan using proceeds from personal assets if necessary.
Business Plan and Projections
A lender wants to know two main things: how you plan to use the money and how you plan to pay it back.
Documentation is important and one of the key pieces of documentation is your business plan. Before you apply for a loan, it may be time to take it out, dust it off and update it.
The business plan you wrote when you started the business most likely has evolved. It should be very professional and representative of how you do business.
A well-crafted business plan is a key document in the loan application process. It should detail your business goals, strategies for growth, and how the loan will be utilized to achieve these objectives. A realistic and detailed business plan not only strengthens your loan application but also shows lenders your commitment to the success of your business.
Including Financial Projections in Your Business Plan
Financial projections are an integral part of your business plan. They should include forecasted income, expenses, and cash flow for the next few years. This demonstrates to lenders that you have a clear understanding of your business’s financial future and how the loan will contribute to your growth.
Understanding the Role of Business Industry and Size in Loan Approval
When applying for a small business loan, the industry in which your business operates and its size can significantly influence the lender’s decision. Different industries and business sizes carry varying risk levels, affecting the approval process. Here’s how these factors play a crucial role in loan approval:
- Industry Risk Level
- Lenders assess industries based on their historical performance and likelihood of success. Some industries are considered riskier than others due to factors like market volatility, competition, and economic trends.
- For example, businesses in sectors like restaurants and beauty shops often have a higher failure rate compared to more stable industries such as healthcare or professional services.
- Business Size and Stability
- The size and age of your business also impact loan approval. Start-ups or newly established businesses may find it more challenging to secure loans due to their limited track record.
- Established businesses with a proven history of consistent revenue and profitability are generally viewed as lower risk by lenders.
- Loan Terms and Conditions
- Depending on your industry and business size, lenders may offer varying loan terms and conditions. Lower-risk businesses with strong financials may enjoy better interest rates and longer repayment periods.
- Conversely, riskier industries or smaller businesses might face higher interest rates and shorter repayment terms to offset potential lending risks.
- Availability of Specialized Loan Programs
- Certain industries or business types may be eligible for specialized loan programs offered by government agencies or institutions. For instance, the Small Business Administration (SBA) provides targeted loans for businesses in specific sectors.
- These specialized programs might have different eligibility criteria and more favorable terms, making them an attractive option for businesses in qualified industries.
- Diversification and Market Demand
- Lenders consider the diversity of your revenue streams and the market demand for your products or services. A business with multiple income sources and strong market demand is perceived as more stable and less susceptible to economic fluctuations.
- Demonstrating Industry Knowledge
- When applying for a loan, it’s essential to showcase your expertise and understanding of your industry. A well-thought-out business plan that demonstrates your industry knowledge and outlines growth strategies can inspire confidence in lenders.
| Factor | Description |
|---|---|
| Industry Risk Level | Lenders assess industries based on historical performance, market volatility, and competition, impacting the risk associated with the loan. |
| Business Size and Stability | The size and age of the business influence loan approval, with established businesses viewed as less risky compared to start-ups. |
| Loan Terms and Conditions | Lenders offer varying loan terms based on industry and business size, with lower-risk businesses enjoying better rates and longer repayment. |
| Specialized Loan Programs | Certain industries may qualify for specialized loan programs with favorable terms, offered by government agencies like the SBA. |
| Diversification and Market Demand | Lenders consider the diversity of revenue streams and market demand, indicating the stability and resilience of the business. |
| Demonstrating Industry Knowledge | Presenting a well-thought-out business plan showcasing industry knowledge and growth strategies can build lender confidence. |
Understanding how the industry and size of your business influence loan approval allows you to be better prepared when approaching lenders for financing. By addressing potential concerns and presenting a clear vision for your business’s success, you can increase your chances of securing the funding needed to achieve your objectives.
Risk Assessment from a Lender’s Point of View
Understand the loan process from the lender’s perspective, particularly their risk assessment criteria. Familiarize yourself with how lenders evaluate loan applications, including the review
of credit scores, business history, and the potential risks associated with your business industry. By understanding the lender’s viewpoint, you can better prepare your application to meet their criteria and address any potential concerns they might have.
Building a Relationship with Lenders
Establishing a good relationship with potential lenders can be beneficial. If you’re approaching a bank or a traditional lending institution, consider setting up meetings to discuss your business plans and loan needs. This can provide an opportunity to make a personal impression and establish trust, which can be advantageous in the loan approval process.
Preparing for Potential Setbacks
Anticipating and Addressing Loan Rejections
Be prepared for the possibility of loan rejection. If your loan application is denied, seek feedback from the lender to understand the reasons. Use this information to improve your financial situation or business plan, and explore other lending options that may be more suited to your current status.
Exploring Alternative Funding Sources
In case traditional loan options don’t work out, be ready to explore alternative funding sources. This can include online lenders, crowdfunding, angel investors, or venture capital, depending on your business type and funding needs. Each alternative source has its own set of requirements and benefits, so research thoroughly to find the best fit for your business.
How do Online Lenders Differ from Traditional Lenders in Terms of Small Business Loan Requirements?
This is one of the top loan questions that small businesses have when considering different types of lenders. Online lenders require business credit scores of 500 or better. An online lender is more likely to rely on the business’s cash flow report and history. The annual revenue requirement is also lower at $100,000 (compared to $250,000).
However, interest rates may be higher with shorter loan lengths.
FAQs: Small Business Loan Requirements
To review, here’s what you need to know.
What are the basic requirements for a small business loan?
A credit score of 500-690, annual revenue of $100,000 to $250,000, and lots of documentation.
How can I improve my chances of getting a small business loan?
Submit an organized application with an updated, professional business plan.
Can I get a small business loan with a low business credit score?
You can get a loan from an alternative lender with a 500 credit score, but you’ll pay higher interest rates over a shorter term (higher monthly payments).
What role does collateral play in the small business loan application process?
Collateral such as business equipment and real estate proves that if you default, the lender will still be paid.
How long does it typically take to get approved for a small business loan?
For a traditional lender, the process may take at last two months. For an online lender, the process can be completed within several days.
How does debt to income ratio affect small business loan requirements?
Debt to income shows how much of your small business profit goes to repaying existing debt. Lenders don’t want to see a small number that’s the answer when debt is subtracted from income.
Conclusion
Obtaining a small business loan hinges on several critical factors, with the debt-to-income ratio being a central consideration. Lenders scrutinize this ratio as a measure of a business’s ability to manage existing debt and take on additional financial obligations. Alongside the debt-to-income ratio, meeting the standard loan requirements, such as credit scores, annual revenue, business history, and providing thorough financial documentation, are essential steps in the loan application process.
Furthermore, understanding how the industry and size of your business impact loan approval is vital. Different industries carry varying risk levels, with businesses in sectors prone to higher failure rates viewed as riskier by lenders. Established businesses with a track record of stability and consistent revenue are perceived as lower risk, while start-ups might face greater challenges in securing loans. Additionally, specialized loan programs offered by government agencies can provide favorable terms for qualifying industries.
In the pursuit of small business loans, demonstrating industry knowledge through a comprehensive business plan is crucial. This showcases your expertise and growth strategies, instilling confidence in lenders. Moreover, diversification of revenue streams and strong market demand bolster your business’s stability and financial viability, positively influencing the approval process.
In navigating the lending landscape, business owners must be proactive in improving their financial standing and creditworthiness. By cultivating good financial habits, such as reducing existing debt, increasing revenue, and improving profit margins, small business owners can bolster their credit scores and overall loan eligibility.
Overall, understanding and addressing the factors that influence loan approval, along with meticulous preparation and a clear vision for business success, position small business owners to secure the funding necessary to achieve their goals and drive growth. With these insights, entrepreneurs can confidently approach lenders, increasing their chances of obtaining the financial support required to thrive in today’s competitive market landscape.
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