When you apply for a consumer loan like a credit card or an auto loan, you probably know that most lenders will look at your credit score and income to decide whether or not to approve your application. But small business loans can be more complicated. There are many types of loans, each with different approval criteria. Most of them use three main factors to assess loan applications: income / cash flow, time in business, and credit.
Income / Cash flow
Most lenders want to know if the business has the capacity to repay the loan. Depending on the type and amount of the loan, different types of documents may be required.
For a bank loan, for example, you’ll likely need to provide a two-year (or more) tax return along with at least three months of company bank statements.
Most online lenders will not require detailed financial statements. Instead, they will analyze bank account activity to make a quick credit decision. With this type of loan, the lender can request professional bank account statements (3 to 6 months value). You may need to link your bank account so that the lender can review your bank account activity. Each lender is somewhat different, but they will look for things like:
- Deposits, including the number of monthly deposits and amounts.
- Trends in balances and whether activity is declining or improving.
- Low Balance Days, including the number of days the balance falls below a minimum amount (which varies by lender) and the number of times the account is overdrawn.
- Undisclosed Debt Payments.
Some companies try to keep cash deposits “off the books” to minimize taxes. Realize that if you do this you may not be able to get as much funding as if this income were documented.
Time in business
Many businesses fail, and those that fail often fail in the first few years. As a result, lenders want to see a successful balance sheet. Here they will take into account how long your business has been in business.
Many lenders prefer to lend to businesses with at least two years in business. Make sure you have established an official start date for your business, whether it is the date you incorporated or the date you received your Employer Identification Number (EIN) or a commercial license. Be consistent and use this date when applying for credit.
Some small business lenders do business credit checks, some do personal credit checks, and a few don’t check credit at all.
If a lender checks your business credit through commercial credit bureaus, they may look at your business credit score, check if your business has a positive payment history, or they may just check for red flags such as late payments, tax lien or collection accounts.
Sometimes lenders look at companies’ credit reports to verify UCC deposits. UCC deposits are a type of court record that indicates that other creditors have security interests in company property.
Many small business lenders also check the owner’s personal credit. This credit check can be a gentle inquiry that doesn’t impact your scores, but it doesn’t always. If you are concerned about a credit check, ask the lender what their policy is.
Banks, credit unions, and other traditional financial institutions (including those that provide SBA loans) will generally need good credit (or even great credit). They can check the credit scores of each business owner with a specific percentage of ownership. (In the case of SBA loans, a credit check is usually required for any business owner who owns 20% or more of the business.)
Credit scores can be used both to approve a loan and to help determine the interest rate that will be charged.
There is a fourth factor that will likely affect your lending options, and that is the industry in which you operate. Small business lenders may prefer to lend to businesses in certain industries, or they may avoid others that they deem too risky or simply unsuitable. These will be called “restricted industries” by the lender. (For example, some lenders specialize in medical or veterinary surgeries, for example. Others will not lend to businesses involved in certain types of real estate construction, used car lots or adult entertainment venues, for example. example.)
What are the 5 Cs of the loan?
You may have heard of the 5 Cs of the loan. These are used to help describe the eligibility factors that lenders may look for during the underwriting process. Here are some of the questions a loan officer may ask when reviewing your loan application:
Character: Are you going to repay the loan? Here, the lender will look at your credit history to see if any other debts were paid on time.
Capacity: Can you repay the loan? Does your business have sufficient monthly income and cash flow to make payments? The lender can look at the financial ratios here. In the world of consumer credit it would be a debt to income ratio, while in the world of corporate finance it could be a debt service coverage ratio.
Collateral: Do you have some type of guarantee that could be taken back if you don’t pay it back? This can include equipment or other physical assets of the business, personal assets such as home equity, or even future business receivables.
Capital city: How much have you invested in the business? You can hear this as a down payment, an equity injection, or, informally, as “the skin in the game”.
Terms & Conditions: What are the terms of the loan – interest rates and daily, weekly or monthly debt repayments – that may affect your ability to repay it? The lower your interest rate, the lower your monthly payments, if all other factors are equal. What are the conditions in the industry and / or economy that can impact the business and its future success? Some banks may want a business plan to help document this.
Keep in mind that even an online business loan application can include an automated review of some of these factors. Although a loan officer cannot review every credit report, for example, there may be a minimum credit score. Or by tying your bank account, income can be assessed to help determine if new loan payments will be affordable.
How to prepare to qualify for a small business loan
If this leaves you overwhelmed, you are not alone. Small business loans can be confusing. However, there are a few simple steps you can follow to make your job easier:
1. Use a business bank account. Make sure you use a business bank account for all of your business income and expenses. Don’t mix up personal expenses; if you need to make a personal purchase, pay yourself and then pay those expenses through your personal accounts. Keep your books up to date, so if a lender requires financial statements, it won’t be difficult to put them together.
2. Check and monitor your business and personal credit. If you have business partners, it’s a good idea to discuss your credit scores with each of the major credit bureaus so that you all know what to expect if you decide to seek financing from a verifying lender. personal credit. (Here is a list of over 138 places to check your credit scores for free.)
3. Seek financing before you need it. Borrowers scrambling for last-minute financing are unlikely to get a good loan. At a minimum, you might want to get a line of credit or at least get a business credit card so that you have that credit available if an opportunity (or crisis) arises.
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