How to Get a Business Loan: Step-by-Step
Getting a business loan can be challenging for most small business owners. Many don’t realize that preparing to get the best loan can take years of foundational work. Others aren’t aware of alternative lending options that can help newer businesses, or those with an urgent need, obtain the money they require. Fortunately, there are a number of things you can do to improve your chances of getting approved for a loan. The following strategies explain how to get a business loan successfully.
Four Strategies to Help You Understand How to Get a Business Loan
1. Get Your Personal Credit in Order
When you’re just starting out in business, your personal financial history will play a major role in your company’s ability to obtain financing. Almost any type of loan or credit you take out will need to be personally guaranteed. To get the best rates and to have the most options, you’ll need a personal credit score of at least 700. It’s easy to check your personal credit score online, and you’ll want to do that right away as you prepare to apply for a small business loan. To improve your credit score, start paying down your debts and stop applying for more credit. Look for any errors in your credit report and file for a correction immediately – you might be surprised how often this can make a difference. If your personal financial situation is dire, it might be best to wait on getting a business loan until you can move into a more financially secure position.
2. Build Your Business Credit
Many entrepreneurs don’t realize the importance of business credit. Building good credit for your business is essential to enabling your company to access all types of business funding and to gain the most favorable rates and terms. One of the most heavily weighted elements in calculating business creditworthiness is operating history. When you’re starting your company, try to establish it as an entity separate from you personally as soon as possible. This means obtaining a local business license and any relevant legal filings (LLC, DBA, partnership, etc.). Your company should also acquire its own phone number, website, and a mailing address (even if it’s a post office box). This will go a long way in demonstrating a stable business history.
Open bank accounts in the business’ name and obtain a business credit card. You will be guaranteeing it personally at the beginning, but this is a major step towards getting a business loan. Establish relationships with your vendors and suppliers and ask them if you can pay on terms (e.g. net 30 payment). Terms are another form of credit. Use your credit sparingly and pay on time. Even if you don’t need it, use it occasionally to show future lenders that you are able to manage and pay off debts.
Monitor your business credit score regularly so you can contest any errors and make adjustments in areas that need improvement. You can request a copy of your business credit report from each of the major credit bureaus (Dun & Bradstreet, Experian, and Equifax) or you can subscribe to a credit monitoring service. Keep in mind that business credit is scored on a scale from 1 to 100 (100 being the best). Generally, a score of 75 or higher is needed to secure a traditional bank loan.
3. Write a Thorough Business Plan
Presenting a detailed and thoughtful business plan can make a big impression when getting a business loan. Make sure you follow best practices (there are many books and online resources that explain how to write a business plan) and forecast at least three years out. When it comes to money, be precise. Research costs and have exact figures rather than a range when outlining your borrowing needs. Explain how and why your intended investments will help your business grow. Be prepared with supporting financial documentation, including projections, balance sheets, and recent tax returns.
Your business plan should not just address finances, but why your company is a smart investment for lenders and alternative lending companies. Include background information on all your team members and explain why your company is different and better than competitors. Discuss the growth potential in your market and illustrate your strategies for getting a percentage of that market share.
4. Decide Which Type of Loan and Lender Are Best for You
Before you dive in and start applying to get a business loan, take some time to research all the loan options. Consider the following during your research:
- Term length: How long will it take you to pay back the money you’re borrowing? What is the useful life of whatever you’re purchasing with the borrowed money? When will you need to replace the purchased item, or reinvest in it next?
- Monthly payment: How much can you comfortably afford to pay each month?
- Interest rate: Can you get a reasonable rate now or should you hold off until circumstances change?
- Timing: Do you need money immediately? Can you wait a bit?
- Risk: Is it preferable to have a secured or unsecured loan? Can you qualify for an SBA loan? Do you have appropriate collateral?
- Lender: Should you work with a traditional bank, a microlender, or an alternative lender with less strict requirements?
- Loan Type: Is a conventional loan a good fit, or would another loan option like invoice financing, merchant cash advance, or a business line of credit be a better match for your company?
Your business and personal credit scores, your business’ history, and how you plan to spend the money, among other factors, will influence which of these options apply to your business.
Factors That Determine Your Chances of Getting a Business Loan
Lenders weigh a number of elements when determining whether or not to loan money to your company. These factors also affect the terms and interest rate a lender will offer. Knowing what lenders are looking for can help you understand how to get a business loan that best fits your financial needs.
- Time in business: The longer you’ve been in business, the less risky you appear to potential lenders. Many lenders won’t invest in companies that have been operating for less than two years.
- Type of business: Some kinds of businesses are riskier than others, whether it’s due to intense competition in the space, potential liabilities, or delicate legal regulations. These include restaurants and bars, clothing stores, and money service businesses. As such, a lender might choose not to work with certain types of companies, charge a higher interest rate on the loan, or require the loan to be personally secured.
- Credit score: Your credit score tells lenders how well you’re able to responsibly manage debt. If you don’t have a good track record, a traditional lender likely won’t be willing to take a chance on your company.
- Revenue: Simply put, a lender needs to know that you have a steady stream of money coming in to make your loan payment each month.
- Collateral: Businesses can often get better terms if the loan is secured by collateral. The collateral can belong to the company itself or its owners. A loan that is secured in this fashion means less risk for the lender and more favorable outcomes for the borrower.
- Economic climate: The federal interest rate varies, which can impact your chances of getting an affordable loan. The lending climate also fluctuates, with banks tending to shy away from small business loans during strained financial times. Though your company has no control over whatever is influencing the economy, these factors can significantly sway your ability to get a business loan.
Some alternative lenders are starting to turn away from these traditional qualifiers and look at new elements to determine potential business success, such as social media influence, Yelp reviews, and shipping habits.
Why Is It Difficult to Get a Business Loan?
Quite frankly, lending to small businesses is a risky proposition for banks, other lenders, and alternative lending companies. According to the SBA, one-third of new businesses fail during their first year, and half will close by their fifth year. Those are not good investment odds.
Additionally, underwriting a large-scale loan costs a lender the same as underwriting a small-scale loan. However, a larger loan has the potential to bring in much higher revenue. Lending to businesses who are looking to take out a small loan is simply not as cost-effective for lenders, so they tend to focus on it less.
Traditional lenders have high standards and require such an intense vetting process because they want to be sure they are going to make money on their investment. They don’t want to give cash to a company that’s going to squander it, go out of business, and default on the loan. Alternative lenders have less strict requirements, but they often make up the difference by charging fees and much higher interest rates.
Since the recent recession, lenders have been subject to tighter banking regulations that discourage risky investments. In an effort towards more cautious portfolio creation, many lenders have raised their standards for small business loans even further.
All of these hurdles can be overcome with the right education and planning. Knowing how to get a business loan, preparing your company for the application process, and investing the time into grooming your company as an ideal loan candidate can pay off tremendously. By focusing on your personal and business credit, creating a thorough business plan, and researching the best loan and lender fit, your company will be on track to getting the business loan it needs to reach the next level of growth.