What lenders offering small business loans want is no mystery. Do your research and know the lender’s qualifications and requirements prior to applying.
Compare different lenders and loan types. Look at the minimum criteria required as each lender will have different practices
Even when applying for a small business loan, a personal guarantee and collateral are typically required. The lender may also take a blanket lien against the business assets. Both your personal and business credit scores and histories will be examined.
How to Qualify for a Small Business Loan
Their primary consideration is that you be able to repay the loan promptly. They want to see excellent financials, high personal and business credit scores and a strong business plan.
Ability to Repay
Important factors reviewed to determine ability to repay include:
- Bank statements
- Assets in the business
- Financial statements
- Debt Service Coverage Ratio
- Having a sound business plan
- Personal and Business Credit Score
- Bank rating (if borrowing from a bank)
Loans are frequently declined because the lender is unable to easily determine which of their research belongs to your business versus another entity’s.
Ensure that you use exactly the same business name, physical address, and phone number on your bank statements, tax forms, incorporation papers, utility bills, and online site. Your company, LLC is not the same as your company.
If an address or phone number changes, take the time to change it on every license and document related to your business.
Lenders use bank statements to determine how credit-worthy you are. What they are looking for is consistency as explained in this excellent video on what lenders review when looking at bank statements.
They prefer businesses that have a substantial volume of regular deposits. Work to avoid drops or declines because lenders prefer businesses that have revenue that is steadily increasing over time.
Banks want to see an average minimum daily balance of $10k+ over 90 days. Manage your bank accounts to keep your average daily balance as high as possible. Avoid overdrawing your account and using overdraft protection.
Assets in the Business
Lenders like to see assets they can seize to cover your loan obligations if you fail to repay. This includes accounts receivable and that high daily balance they like to see in your business checking account.
Personal guarantees are often required for loans to businesses with insufficient assets. If your business has sufficient assets to guarantee the loan, avoid having to provide a personal guarantee if possible. Personal guarantees put your personal assets at risk as well as the company’s.
Ensure your financial statements are accurate and comprehensive. Lenders use your balance sheet, cash flow statements, and income and loss statements to analyze:
- Earnings before interest, taxes, depreciation and amortization (EBITDA)
- Gross margin
- Cash flow
- Debt-to-equity ratio
- Accounts payable
- Accounts receivable
Financial statements that have been audited by a certified public accountant (CPA) are preferable. Having your financials reviewed by a CPA is faster and cheaper, but some lenders will require audited financials. Ask the lender what they require.
Debt Service Coverage Ratio (DSCR)
All lenders will use your financial statements to calculate your company’s debt service coverage ratio. They typically look for an amount that is less than 1.25-1.35 times your expenses including the loan under consideration.
How each lender calculates the DSCR may vary but will include dividing annual net operating income by total principal and interest of all debt obligations.
Additional factors are often taken into consideration such as tax obligations, seasonal fluctuations in income, upheavals in your niche, and anything else that lender deems important.
A DSCR of less than 1.0 indicates negative cash flow and a likely inability to repay any new debt incurred.
Your business plan needs to include how you plan to spend the loan proceeds and realistic financial projections for future growth.
Include market information and details on the status of your business niche and how demand for your products and services is growing.
Lenders want to know your business strategy considers changes in the market and how it will increase your profitability and ensure loan repayment.
Personal and Business Credit Scores
Both your personal and business credit scores will be reviewed because lenders want to know how you manage your money. Review your credit reports and have inaccuracies removed.
Work toward further improving credit scores by:
- Scheduling your payments to ensure you pay them on time
- Reducing your debt
- Keeping a low utilization of your available credit
- Opening a business credit card
For an established business in a strong financial position, personal credit scores are less critical.
Did you know that lenders have their own internal bank ratings? Your bank rating is the total amount of borrowing capacity that a business can obtain from a bank.
The date your business bank accounts are opened is used as the start date of your business. More established businesses have an easier time borrowing.
To get a bank rating of low 5, you need a bank reference (the person you work with at your bank), and ideally a $10,000 average daily balance (ADB) over three months. (Low 5 means a business has a $5000-$35000 ADB.)
While you can get a loan with a high 4 bank rating ($7000-$9999 ADB), the process will take longer. Apply for loans when your ADB is highest to increase your chances of loan approval.
Eliminate insufficient funds (NSF) and generate an active positive cash flow. You cannot just leave a high balance sitting there; your business must be actively generating a steady volume of regular deposits.
Know How to Qualify For a Small Business Loan Now?
Understanding what lenders are reviewing when you apply for a loan enables you to focus on improving your chances of landing a loan for improvements or growth.
Apply these tips and you will know how to qualify for a small business loan.
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