“Can I still qualify for business loans after bankruptcy?”
It’s a question small business owners and aspiring entrepreneurs who have suffered that fate may ask when looking for financing. If you want a fresh start, a past bankruptcy need not be a life sentence. It is possible to get approved for a business loan after bankruptcy.
Realistically, it will require you to put together a strategy and expend extra effort. And it may take a while and involve a series of baby steps, but in time it is possible to overcome the effects of bankruptcy on your financial prospects.
A bankruptcy will stay on your credit history for 10 years in the case of Chapter 7 and seven years from the filing of Chapter 13. Also, expect your score to plummet — 130 to 240 points depending on your credit score, according to a FICO scoring model. Nevertheless, you can take action to improve your chances of getting that business loan or find capital from alternative sources.
How Do I Get a Business Loan After Bankruptcy?
Getting a business loan following a Chapter 7 bankruptcy or Chapter 13 bankruptcy will be tricky, especially in the current economic environment. The following strategies can help:
1. Get a Secured Credit Card
Secured credit cards require a cash payment as collateral (That’s why they’re called “secured.”) That deposit serves as your line of credit. While it’s not the ideal, secured cards are a way to rebuild your credit and have the functionality of a credit card for purchases.
2. Pay Your Bills on Time
We cannot overstate the importance of paying bills on time. It has the greatest impact on your credit score of all the contributing factors. If you do it long enough, you prove to lenders than you can manage your finances and stay out of trouble.
3. Consider Alternative Lending Options
Banks and other traditional lenders may be reluctant to offer a loan after bankruptcy — federal and state regulators tie their hands. One option is alternative lenders that provide term loans and lines of credit, albeit at higher interest rates and fees. Your chances of getting small business loans for bad credit are higher; just understand the risks and potential liability if you’re unable to make payments.
Revenue-based financing, such as merchant cash advances or invoice factoring is another option — so long as your business is bringing in solid sales. These financing sources generally aren’t that concerned with your credit score, although they may run a soft credit check on your personal or business credit.
Asset-based loans are yet another option worth considering, particularly when approaching a bank.
“Traditional lenders are going to look to cash flow, assets, or some type of security,” said Luis Salazar, a bankruptcy attorney in Miami, Florida, in an interview. “The best security is a strong piece of collateral that you know you could sell to recover your loan.”
Another option, crowdfunding, isn’t dependent on credit scores, but you’ll need to invest in a marketing campaign or have a loyal customer base willing to pitch in.
4. Get a Cosigner
Some lenders allow you to apply for a loan using a cosigner. The risk to the cosigner is that they become responsible for the loan if you fail to make payments on time or, worse, default. Also, they receive no benefits to their credit if you repay on time. Make sure the person understands those risks before signing on the dotted line.
5. Present a Business Plan
Hari R. Ender, bankruptcy attorney, writing for Nolo.com, said, “Before you try to get credit for your business, make sure you have a solid, organized business plan to present to potential lenders. The industry in which you are seeking a loan might also make a difference as to your success.”
6. Share Bankruptcy Details with Lenders
Marina Vaamonde, a commercial real estate investor in Houston, Texas, advises business owners to create a timeline accompanied by a set of factual documents that will allow them to share their bankruptcy story.
“Include an overview of how and why you fell into bankruptcy,” she said. “Have a detailed explanation with examples of how you have been managing your business and finances after the bankruptcy. The presentation should allow the lender to learn more about your situation and have a more positive impact on your application.”
There is a place on your credit report to submit a brief explanation of what major event caused your financial difficulties and how it is different now. Typical causes are divorce, hospital bills, extended illness, or a car accident.
7. Avoid ‘Reaffirmation Agreements’
You may volunteer to make repaying your creditors part of the contract — a “Reaffirmation Agreement” — even if you can discharge your debt. Salazar says that’s a bad idea that you should avoid.
“I’ve often had clients say they want to include paying certain creditors back as part of the terms of the bankruptcy,” Salazar said. “I tell them, you can always voluntarily pay someone back, but don’t file bankruptcy and make an agreement that you will pay them back, even though you feel an emotional and moral obligation. If your fortunes turn, you can always send money, but don’t agree to do that in the contract.”
8. Keep Your Credit Debt Level Low
Keep your revolving credit debt as low as possible — below 20% is best — to show that you are not overextending and can afford to make payments. Also, keep in mind that your personal credit affects business borrowing. (That’s especially true for minority business owners who rely heavily on personal scores.)
“If you are cash poor, make sure you don’t take on more loans post-bankruptcy, as it could hurt you,” said Leslie H. Tayne Esq., founder and head attorney at the Tayne Law Firm, in an interview. “Following bankruptcy, it’s not unusual to get credit card offers. Don’t put your personal credit on the line by taking everything you can and maxing out your available credit.”
She added that lenders will look at your personal credit report to see if you have been managing your finances responsibly. “A credit report tells a lot about a person,” Tayne said. “Getting over-extended again could demonstrate a pattern of behavior, making it harder to get a loan.”
9. Go the Friends and Family Route
If you are still having trouble getting a loan after bankruptcy, consider turning to friends and family. The Federal Reserve Bank 2020 Small Business Credit Study (PDF) found that 56% of business owners have relied on friends or family, as well as personal funds — the biggest source of financing — to finance their enterprise in the last five years.
If you decide to go that route, find someone with good credit who can add you as an authorized user to his or her account. Your credit use gets reported in both your name and the primary account holder’s name. Also, you may be able to get a friend or family member to cosign on a loan. Just make sure they understand the risk.
10. Bide Your Time
Our last piece of advice is to wait. It takes up to 10 years to discharge a bankruptcy. If you can’t wait that long to apply for a business loan, you may have to hold off at least a year and likely longer. Even alternative lenders require a waiting period before they will consider making a loan. SmartBiz, for example, requires a three-year waiting period while Funding Circle mandates seven. Some, like OnDeck and DealStruck, are more lenient. They only need a two-year waiting period.
FAQs About Bankruptcies and Loans
The above points will help you create a strategy to get a loan after bankruptcy and improve your credit scores. The answers to the following frequently asked questions provide additional information about the impact of bankruptcy on business loans:
Can you get new business loans while still in Chapter 13?
Getting a business loan while in Chapter 13 bankruptcy will be tough, but not impossible. The Bankruptcy Code allows you to incur certain types of new debt, but you will need to get the court’s permission and be current on your plan payments.
What happens to my existing business loan if I file a Chapter 7 or Chapter 13?
Filing Chapter 7 bankruptcy discharges any personal liability for the business loan but not the debt itself. The reason is, unless you are a sole proprietor, the business is a separate legal entity and remains responsible for replaying the obligation.
A small business set up as an LLC or corporation cannot file Chapter 13 because it is for personal use only. Sole proprietors can file Chapter 13, however, and reorganize and pay back both their personal and business debts, including loans.
Can I discharge an SBA loan in bankruptcy?
Many people mistakenly believe that because the SBA is a federal agency, loans are not dischargeable in bankruptcy. The truth is, you can discharge an SBA loan. There is a catch, however. If you pledged any assets as collateral, bankruptcy would not remove the lien, and the lender can foreclose on or repossess that property.
Although bankruptcy will drop your credit score dramatically and stay on your credit file for 7-10 years, you can still qualify for a business loan. And because you could have less debt and cannot declare bankruptcy again right away, some lenders may consider you less of a risk.
Take steps now to improve your personal and business credit so you can demonstrate that you are a better credit manager. Even though some lenders don’t require your bankruptcy to be fully discharged, the longer it has been since you filed and the lower you have kept your debt, the better.
If you are a business owner who is considering filing bankruptcy, speak with a bankruptcy attorney. He or she can explain the laws clearly and show you the best options for protecting your business interests.