Small businesses play an important role in the economy. In the U.S., small businesses create two-thirds of net new jobs and account for 44 percent of U.S. economic activity. Yet, so many face difficulties in accessing financing. By understanding the six key factors that determine the outcome of a business loan application, you can learn how to maximize your success.
1. Credit Score
Credit scores demonstrate your creditworthiness and likelihood to pay back a loan. In other words, the lower the credit score, the higher the perceived risk that a credit applicant will default or become delinquent. As such, one of the first business loan requirements is for both the owner and the business to have good credit scores.
Lenders will pull your personal credit score and request for information such as your income, net worth, available credit, prior delinquencies, and prior bankruptcy. We recommend reviewing your personal credit reports at Annual Credit Report at least once a year to dispute any inaccuracies. Experts recommend aiming for the threshold of 760 and beyond to demonstrate strong personal finances and thereby attain more favorable loan terms. To boost your credit score over time, ensure that you pay all your bills on time and spend below the credit limit at ideally, 30% or less.
Similarly to your personal credit, a business has its own credit score. You may check this score at the three credit bureaus: Experian, Equifax, and Dun & Bradstreet. While each scoring model is different, factors such as company size, age of credit history, payment history, industry risk, and debt usage are considered. That said, paying bills to suppliers and lenders on time is your strongest bet to boost scores into the ‘excellent’ range of 80 and beyond.
2. Annual Revenue
Revenue is a major criterion to qualify for small business loans as it reflects the strength of your business. Intuitively, if a borrower’s monthly revenue is below the minimum loan repayments, it is highly unlikely that the borrower would pay on time or pay at all.
While your revenue gets you in the door to apply, lenders typically want to look at other financial information to ascertain that you can repay what you borrow. This may include your balance sheet, cash flow, profit and loss (P&L) statement, bank statements in the past few months as well as business tax returns in the past two years.
The exact criteria will vary by lenders and loan types. Banks typically have higher annual revenue requirements and are known for their length application process. As such, by filtering out lenders whose requirements you are able to meet will not only save you time to look at alternative loan options but boost your chances of loan approval.
3. Time in Business
Essentially, this refers to the age of your business. It is a common assumption that the older your business, the more stable it would be and presents less risk than a new one. The rule of thumb is a minimum of two years in business. That said, if you fall short of the specified period, it is still possible to apply if you are able to prove a strong business plan or put up collateral. Do not be discouraged if you are a start-up as there are other viable financing options specifically for new businesses in mind.
4. Business Plan
A business plan may not be a prerequisite but it is best to include it in your application. It should explain how the loan would be used and the size of the opportunity you would then be able to capitalize on. It should also identify the key risks and challenges as well as strategies to manage them. A well-thought-out plan would also include a timetable to achieve your business goals and financial projections.
There are two types of loans - secured and unsecured. An unsecured loan is only backed by the borrower’s creditworthiness and tends to have a higher interest rate. If lending institutions want to err on the side of caution, they may offer you secured loans which are backed by collateral.
To lenders, collateral is akin to safety nets. If the borrower fails to meet the repayment terms. The lender has the right to seize liquid assets such as the company’s real estate or account receivables in lieu of payment. In some cases, lenders may ask the company owner to provide a personal guarantee to the loan or pledge their own assets as collateral.
The size of the collateral will depend on factors such as the loan amount, the purpose of the loan as well as your credit history.
Each industry has a different level of risk and will affect your eligibility for the loan. Additionally, each lender will have a different list of industries or the nature of businesses that precludes them from applying. This may include not-for-profits, firearms, gambling, and adult entertainment. Ensure you check with the lender on any industry preclusions before submitting your application. It is also important to correctly identify your industry code. You can look up your code on the North American Industry Classification System (NAICS) website. This will prevent delays or mistaken rejection of the application.
Finding the right loan for your business can be difficult. However, researching the requirements of various available lenders will go a long way in identifying a loan that fits your small business needs. It is also good practice to improve credit scores as well as having updated financial information at your fingertips. This will help you prepare for your loan applications and improve your chances of success.