Qualifying for a small business loan is based on a couple of factors: your personal credit history; how long you’ve been in business; the type of business you run; and business revenue. Because many alternative loans are uncollateralized, lenders who back them will be especially interested in your finances, including not only your credit report but also expense reports and revenue forecasts. The financial figures help lenders determine how much capital to provide. They also provide a level of assurance that you can pay back the loan.
Personal Credit History
Any lender, banking and non-banking, will ask to see your personal credit report. It’s one of their best practices as it gives them a good idea of your risk, or credit worthiness. It also is one of the deciding factors in your loan’s interest rate. Some lenders may ask for a business credit report, too, but only if your company is large enough to warrant one.
Generally, a credit score of 600 or greater will qualify you for most alternative loan products. Banks and more traditional financial institutions are the exception; they almost always set the minimum credit score at 650.
Some lenders may give you a loan with a lower credit score, but that doesn’t mean you should do it. The higher your credit score, the better positioned you are to ask for more advantageous terms, such as lower rates and longer payback terms.
The good news? U.S. consumer credit scores are improving.
- The national average FICO score is at an all-time high of 695, up from 688 in 2005.
- Fewer consumers have scores lower than 550 (12.5 percent in 2015 as compared to 14.6 percent in 2005).
- More consumers have scores of 800 and above (19.9 percent in 2015 versus 16.9 percent in 2005).
The score, however, isn’t the only factor under consideration. Lenders also scrutinize the following.
- Credit Inquiries. Lenders tend to view you as less “risky” if you aren’t shopping around for credit.
- Established Credit. You will be viewed more positively if you have a long credit history; it shows how responsible you are with paying down debt.
- Credit Accounts. Lenders prefer applicants with established credit histories with at least five to six other lending institutions. These can include personal credit cards, automobile and student loans, and mortgage payments. The variety of lenders, if paid on time, improves your utilization ratio, which boosts your score.
- Repayment. Lenders want to know you’re a good investment, so they look for small business owners with no late payments and few delinquencies.
- Public Records. Lenders will also pay attention to bankruptcies, foreclosures, civil suits, and liens, again to protect themselves from risk.
The five items are factored into your total credit score, but lenders often look at them in closer detail, particularly if some of their qualification rules relate to them.
Because of that, it’s good to have an accurate understanding of your credit report prior to applying for a loan. You can get a free credit report from services like Experian, Equifax, Credit Karma, or MyFICO. Once you have it, look at the five items detailed above. If you see any items that could hamper the loan application process, either delay applying for one or share your concerns upfront. Doing so will save you and the lender time and possibly make the lender more amenable to your loan request.
Do be careful when you start looking for a loan; every time you or your lending agent submit an application, a record of it goes on your credit report. Even if your report is pristine now, the quality could easily change.
While you do need to comparison shop, you should exercise wisdom. Do some preliminary research. You don’t have to apply with every lender, simply the ones who might be more likely to source your working capital.
You should then ask those lenders whether they would make a hard or soft inquiry. A hard one will go onto your credit report and stay there for up to two years. A soft inquiry doesn’t impact your score in any way. By asking about which type the lender you will use, you can avoid harming your credit report.
A final note on credit reports: credit bureaus like Experian and TransUnion will notice you’re comparing loan products and give you a 14 to 45-day window to finish the work. If you’re worried about your score, though, you can always contact them and ask for a grace period outright.
Time in Business
Some lenders offer loan products to small businesses that have been in operation between six months and one year, but it isn’t the norm. Most lenders only work with small businesses that have been in existence for two years or more.
Just as there was good news for credit scores, there is good news for average time in business, too. Statistics from the Census Bureau and the SBA show that most businesses surpass the two-year mark.
- 7 out of 10 new small businesses beat the two-year hurdle;
- Half stay in business for at least five years;
- A third keeps operating at least 10 years;
- And a quarter stay in business 15 years or more.
If you’ve been in business longer than that, you could qualify for even better rates and terms. You pose less of a risk to the lender, and that means they’ll be more likely to work with you. You have history and revenue to backup your loan application. It may not be a hard asset, but it still offers an assurance of security to lenders.
Business Entity Type
Generally, lenders prefer businesses that have been set up as an LCC or S-Corp. The corporate structure helps with regulation and compliance and communicates that you plan to be in business for a long time. Plus, the structure is to your benefit. It protects your personal assets from being seized if a debt goes to collection.
If you don’t have a corporate structure in place, it’s relatively easy to set one up. Many financial services, including online vendors like Intuit and The Company Corporation, offer assistance with preparing necessary documentation and filing the right forms.
Even with a corporate structure in place, you could face more stringent qualifications due to the vertical you’re in. Some industries, including construction, transportation, and automobile dealerships, are inherently riskier because of the product or service provided. This doesn’t mean you’ll be unable to get a loan if you’re in one of those industries; rather, you’ll simply face additional application requirements.
Also know that some lenders won’t finance certain industries as a matter of policy. The industries vary by lender but often include adult entertainment, gun shops, marijuana dispensaries, and nonprofits.
Revenue, Profit, and Cash Flow
Lenders who offer working capital financing tend to care more about your business revenue rather than profit projections. Because the loan is for a short period of time, lenders want to know you have the cash flow needed to pay it back.
The minimum revenue threshold for most online lenders is $100,000 per year. The more revenue you have, the better rates and terms you qualify for—the same as you do with time in business. But be prepared: you’re going to be in competition with other small businesses for many of these loan products, and some of the most competitive ones require you have at least $500,000 per year in revenue.
Before shopping for a loan, you should create a loan application packet that contains the following documentation. It will save you and the lender time and energy.
- Personal Credit Report. Lenders will want to see your credit history. They may also ask for a business credit report.
- Bank Statements. Lenders will review statements from your primary business accounts. If you have online banking, you can give the lender read-only access so that they can review the statements electronically.
- Public Records. Lenders will look for tax liens, bankruptcies, legal judgments, business licenses and registration, and outstanding loan balances.
- Property Leases or Landlord Information. A dedicated business location conveys you have a stable business. You may still be able to get a loan with a home-based business, but it will be harder to qualify for one.
Lenders use the information to confirm two points. The first is your ability to pay back the loan. The second is the likelihood of fraud. Fraud can ruin a financial institution, so lenders do their best to identify the potential for it during the loan application phase.
The four pieces of documentation are staples for the loan application process, but others will be required if seeking a loan larger than $100,000. You will be asked to provide tax returns, usually the past three years; business financial statements, such as profit and loss (P&L) reports and balance sheets; and additional months of bank statements. If you know you’ll be seeking a larger loan, it’s wise to prepare these items and include them in your loan application packet.
Use this information to start the process today!