How to Qualify for a Small Business Loan

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Business owners periodically need additional capital for a variety of reasons, such as additional staffing, expanding business services, or catching up after an economic downturn. Not every business owner has ready cash to cover these expenses. That’s where business loans come in.

Important Factors to Consider

Bank of Labor’s Senior Vice President/Commercial Banking Division Manager, Joe Keller, recommends that business owners who need to boost cash flow first familiarize themselves with the different types of loans that are available. He advises entrepreneurs to talk with their banker about what their goals and needs are so that the bank can determine what type of financing will be the best fit for their business.

Keller also recommends that business owners check to make sure they have all the documentation that lenders will need when they meet with them.

While many lenders have similar requirements, you may run across additional criteria and documentation requests, depending on the type of financing you choose. That said, here are some basic steps that can help you qualify for a small business loan.

1. Credit

When considering any type of financing, your credit score is going to come into play. Most lenders are going to look at both your personal and business credit history and scores. Because most small business owners haven’t established business credit, personal credit history becomes an important factor.

If you want to secure a small business loan, you will need a satisfactory personal credit score. You can get a free annual credit report from each of the major credit bureaus to examine your credit history. If there is something inaccurate, you should take the time to dispute those items. Doing this could raise your credit score.

2. Cash Flow and Income

Cash flow and income are other important factors. If you do have a steady stream of cash coming in, lenders will view this favorably. However, if you are strapped for cash, it may not be a “deal-breaker” with most loans, since financing may unlock value in other parts of your business, such as with your equipment, inventory, or even your real estate.

Lenders will also look at your overall income levels to determine your business’s profitability. Some businesses are profitable but still have trouble with issues like unpaid invoices. Fortunately, there are options available, like invoice factoring and receivable financing, that provide you with the cash flow you need.

3. Age of Your Business

Roughly three out of ten business fail in the first two years of operation, so it’s not surprising that many lenders require that companies be in business for a minimum amount of time before granting a loan. In most cases, that minimum averages about two years.

It’s important to note that the age of your business is not the only factor lenders take into consideration. In addition, they want to see how long your business bank account has been open.

4. Current Debt Level

Lenders are also interested in how much business debt you already have. Specifically, they will need to calculate what percentage of your monthly gross income will repay your debts. This is referred to as your debt-to-income ratio. Ideally, that ratio should be 50 percent or lower.

Lenders will also want to look at your business balance sheet. This is a basic financial reporting document that shows your assets, liabilities, and business equity. This report helps lenders determine if you are in a strong enough financial position to repay a loan.

If you have existing business debt, you can strengthen your position by paying some of it off. If you are using all your available debt, it appears as if you are a high-risk borrower.

5. Collateral

Some lenders might require collateral for a small business loan. Collateral is defined as assets that you already own or might purchase with proceeds from the loan.

Some lenders will require that business lenders put up both business and personal collateral for a loan. Others won’t require collateral at all. However, those generally carry a much higher rate of interest. The type of loan you choose and the lender you work with will dictate whether collateral will be an issue. However, it’s important to note that you will likely be able to borrow more money and get better terms if there is collateral on the loan.

6. Type of Industry

Finally, the type of industry you are in can play a role in your eligibility for a small business loan. For example, some lenders will not lend to businesses involved in specific industries because they are considered high-risk or there are legal implications. A few examples include the adult entertainment, gambling, and marijuana industries.

Even if you aren’t in one of these industries, you might run into some challenges if your business is seasonal. Businesses that have unstable cash flow might appear to be at higher risk to some lenders.

Bottom Line

Most small businesses require financial assistance at some point to boost cash flow or fund expansion.

Keller says, “It’s very common for business owners to take out and pay off a series of loans throughout the life of their business to finance equipment, inventory purchases, and real estate.”

It’s important to understand various lenders’ requirements when applying for small business loans. The better positioned you are with these different factors, the greater chance you’ll have of a loan approval and favorable terms. If you aren’t eligible for one type of loan, don’t give up. There might be another form of financing available that will suit your needs and goals perfectly.

If you would like to inquire about a small business loan, take a look at our business lending services or give us a call at 913.321.4242.