The 3 Most Important Qualifications for a Business Loan
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When it comes funding a business, the options are nearly endless. When it comes to small business loans, most businesses are not finding fixed-rate, long-term ones from traditional financial institutions. In fact, big banks approve only 25 percent of small business loan applications they receive. Small businesses these days are turning to small banks for small banks (49 percent approval rate), institutional lenders like insurance companies and pension funds (64.3 percent approval rate), alternative lenders (56.6 percent approval rate) and credit unions (40.3 percent approval rate) for loans.
All lenders have different approval processes and qualifications, but at the end of the day, there are three qualifications for a business loan that typically make or break your loan application: personal credit, business age and business revenue. The requirements for each will vary by lender and loan type. Regardless of where you get a loan, the better your standings in those three categories, the better your chance of getting one with good terms, said credit expert Gerri Detweiler, education director at Nav, a company aimed at educating small businesses on financial issues.
Major loan factors
Here’s a closer look at the three qualifications for a business loan that almost all lenders weigh the most when deciding to approve your loan. It’s important to understand why these qualifications are important, what the typical minimum requirements are and if there’s anything you can do to improve your standing before you apply for a loan.
1. Personal credit
Your personal credit score trumps your business credit in almost all cases. That’s because most lenders consider personal credit a better indicator of how responsible you are when it comes to paying your bills and paying down debt. Most traditional lenders will want a minimum credit score of 680. Many alternative lenders — typically those online) will go as low as 600 or 620. The better your credit, the better your interest rate. You’ll get your best terms from banks and credit unions, but you’ll almost always pay much more in interest from online lenders, especially if your credit is poor.
Before you apply for a loan, take a look at your credit report. By law, you’re able to order your report from all three credit agencies for free every 12 months from this AnnualCreditReport.com. When you review your report, ensure all the information is accurate, then take these steps to raise your score if it’s on the low side:
- Pay off or pay down some of your outstanding balances. If the amount of debt you owe is close to your credit limit, that will likely negatively impact your score.
- Always pay your bills on time.
- Shop for credit carefully, Detweiler said. Almost every time you apply for credit or a loan, the lender pulls your credit report — and each pull dings your credit score. Be careful how many credit or loan applications you fill out — a good rule of thumb is to have six or fewer credit inquiries in the last year.
If your credit score is 680 or above, you’ll have a lot more options, Detweiler said, but your credit score might be less of a factor for some lenders if you look good in the other categories. “Some lenders don’t care about credit if your revenue and time in business is strong enough,” she said.
2. Business age
The majority of traditional lenders will want you to be in business for at least two years before they give you a loan. “That’s the common point where risk is reduced for the lender,” Detweiler said. That way, lenders can see two years of revenue statements, which gives them a good idea of how your company’s finances are. If you’re a new business, you might have a hard time getting a loan from traditional banks and credit unions and you’ll need to look at online lenders — remember, though, that they take bigger risks so they charge higher interest rates.
Many online lenders require only as few as six months time in business. For certain types of funding, such as merchant cash advances or business lines of credit, the requirement for your time in business might be less, even at traditional banks and credit unions, Detweiler said.
Aside from building a time machine, there isn’t much you can do to improve your chances in this category. That’s why Detweiler recommends officially establishing your business ASAP so that you have a longer time in operation if you need a loan down the road.
“A lot of business owners don’t actually know exactly when they started their business because they started it as this kind of side gig,” she said. “The sooner you can, even if you’re not making any money yet, register your business, get your business license, get your EIN.”
If your business has strong sales and you have a strong credit score, that can improve your chances of getting a loan if you don’t have two years in business yet. It also helps if you can offer collateral to secure the loan — many types of bank loans require it — which reduces lender risk.
3. Business revenue
Lenders want to know you have enough money coming in to cover the debt payments. Most traditional lenders want to see that your business has at least $100,000 in revenues a year, and most online lenders look for at least $50,000 a year.
Make sure you have a business bank account so that you can clearly show you have revenues coming into your business, Detweiler said. If you have the time, get your finances in the best shape possible before you apply for the loan by reducing some of your expenses or paying down some existing debt.
Personal credit score, time in business and business revenue are big factors when you’re seeking loan approval, but there are other things lenders consider. In some cases, if you have a lot of strong secondary factors, it could make up for weakness in one of the three main qualifications. Determine if any of the four following factors apply to your business.
It’s true that most lenders will look at your personal credit score, but some might also check your business credit score, known as the FICO Small Business Scoring Service (FICO SBSS). The FICO SBSS score is based on both your personal and business credit history, and scores range from 0 to 300. Most lenders wanting a 160 or above, Detweiler said.
The U.S. Small Business Administration, for example, considers FICO SBSS scores for some of its loans, and the score is part of the mandatory prescreening process for its most popular 7(a) loan. Take steps to improve your personal credit and build up your business credit. For instance, if you don’t have business credit, you might want to get a business credit card, but only if you can pay it off in a timely manner.
Depending on the type of loan and the lender, you might need to offer collateral to secure a loan. Collateral is an asset you offer to the lender to secure a loan in case you’re not able to repay your debt. Collateral often includes real estate, equipment, inventory and outstanding invoices.
Collateral, however, doesn’t always come in the form of a hard asset. Sometimes lenders will take out what is essentially a lien against your assets — such as income coming into your business — via a UCC filing. If you default on your loan, the lender has the right to come after those assets. Lenders won’t be excited to see several UCC filings on your credit report because they’ll know there are other lenders in front of them with claims on your assets, Detweiler said.
A personal guarantee is a written agreement that states you agree to use your personal assets to pay back the lender if your business can’t repay the loan. If you default on your loan, the lender can try to enforce the personal guarantee and collect through your personal assets. Some lenders might require collateral and a personal guarantee.
You can try to negotiate the amount of the personal guarantee — the portion of the loan you would cover in case of default — or even ask the lender to waive it altogether, Detweiler said. “Lenders definitely want to see you have some skin in the game, but if you think your business qualifications justify waiving that, you should ask,” she said.
Business entity type
Some lenders require you to fill out paperwork based on your business entity type — sole proprietorship, corporation, limited liability company, etc. In addition, some lenders will issue loans only to certain kinds of businesses. For example, it can be harder for sole proprietors to get loans because as sole business owners, they are the only ones whose assets can repay the loan.
Documents you need
Getting a loan, especially from a traditional lender, will require a lot of documentation, which means you’ll have to sign a ton of paperwork. What each lender requires will vary, but here are some common documents you’ll need to provide:
- Business financial statements. These include profit and loss statements from the last three fiscal years, a cash flow statement, and your balance sheet.
- Bank statements. Some lenders require the last three months of your business bank statements to verify you have a business banking account and — and enough cash to make your loan payments.
- Current loan documents or leases. If you currently have a small business loan or equipment lease, you’ll need to disclose that. You’ll likely also have to provide a business lease or mortgage if you own the property where you run your business.
- Income tax returns. You’ll need the last three years of your personal and business income tax returns. If you’re a new business, however, an online lender might not require this.
- Ownership and affiliations. Be ready to disclose any other businesses you have a financial interest in. If you have partners, they might need to sign some of the paperwork, too.
- A business plan. Although some lenders don’t require a detailed plan, most traditional lenders do. The SBA typically requires borrowers to submit in-depth business plans. Check out our guide that provides tips for writing a business plan here.
Qualifications by loan type
The type of loan you’re requesting often influences what you’ll need to qualify for it. Here are some more specific requirements for common types of business loans and funding.
These are sought-after loans — and for good reason. They have low interest rates, high borrowing amounts and long terms. But they’re tough to get and require a lot of paperwork and documentation.
- For its most popular loan, the 7(a), the SBA uses the FICO SBSS score to prescreen applicants. You need to score at least 140 to pass the screening.
- You need to meet the SBA definition of a small business, which can have from 100 to 1,500 employees, depending on the industry.
- A business debt schedule is a schedule of your outstanding debt, such as loans and lines of credit. If you have is long-term debt on your most recent bank statement, you’ll need to submit one of these.
- The SBA requires a business plan from everyone who applies for any of its loans.
Term loans provide business owners with lump sums of money upfront — with fixed or variable interest rates — that they agree to pay off within a set period of time. The terms can be as short as three months or as long as 25 years — banks and credit unions typically offer longer-term loans and online lenders usually offer short-term loans.
- Larger banks and credit unions will want you to have at least a 680 credit score, two years in business and 100,000 in revenue, but online lenders will go as low as 600, six months to a year in business and $50,000 in revenue.
Line of credit.
A business line of credit enables you to borrow money up to an approved limit. You pay interest only on what you draw and the line is typically revolving, meaning once you’ve paid off a portion of the line you’ve borrowed, you can borrow that money again.
- Minimum requirements are one year in business, $100,000 in annual revenue and a credit score of 600 or better.
If you need to make a major equipment purchase for your business — multiple computers, a truck, machinery — that’s where equipment financing comes in.
- Business owners might have an easier time getting this type of loan because the equipment typically serves as collateral.
- This type of loan usually requires a strong credit score.
There are three types of invoice financing: invoice factoring, invoice financing and receivable based line of credit. Invoice factoring involves selling your outstanding invoices to a factoring company in exchange for a percentage of the invoices in cash. The factoring company then collects on the invoices themselves.
Invoice financing involves using your accounts receivable as collateral to get a cash advance and paying it back as customers pay their invoices. A receivable based line of credit gives you a credit line based on a percentage — usually 80 percent to 85 percent of your outstanding invoices’ value.
- You’ll typically need $50,000 in revenue and six months in business to qualify.
- Your credit score isn’t as important in invoice financing — especially with invoice factoring — because the lender would be more concerned with your customers’ credit scores.
Merchant cash advance.
A merchant cash advance isn’t a loan, but a cash advance you get in exchange for handing over a percentage of your daily (or weekly) credit card sales to the lender.
- If you have bad credit — below 600 — you would still likely be eligible for a merchant cash advance, especially if you have strong sales (at least $50,000 in annual revenue).
The bottom line
If you’ve been in business for at least two years, have revenues of $100,000 or more a year and a credit score of at least 680 — or, even better, 720 — the world is pretty much your oyster as far as loans go. These are the main qualifications lenders look at, but you’re not out of luck if you don’t meet those standards.
Online business lenders require less time in business and smaller annual revenue and minimum credit scores, but you’ll pay higher interest rates. Do what you can to get your credit scores and revenues up before you apply for a loan and conduct research to make sure you’re applying for a loan that suits your needs — and one you can realistically get.