According to statistics, 43% of small businesses applied for a loan in 2019 alone.
At some point, your firm will need an infusion of outside financing to meet its needs. Whether it’s to scale up, make working capital more efficient or restructure existing debt, you will need to tap a financier for their resources. With such mission-critical needs in mind, you need to understand how a business loan can be a useful part of your arsenal.
Here is an in-depth look at some essential business loan requirements you must consider if you want to land the financing.
Critical Business Loan Requirements That Affect Your Eligibility
In a regular market, there are usually more business loan applications than there are bankable ideas or businesses. As such, you need to focus on getting each issue right if you are to apply successfully.
Whether you’re looking at private money loans or a business line of credit, there are common critical factors you need to work on:
1. Credit Score
For many lenders, the past financial history of a loan applicant can portend what the future holds in terms of liability. Therefore, when lenders are assessing an application for a business loan, they will look at both personal and business credit histories.
If you are looking for capital to start a business, then you most likely may not have a business credit history yet. Your personal credit history becomes even more valuable in such cases.
The lower your credit score (both personal and business), the riskier you seem to lenders. A good business credit score should be north of 80, while an attractive personal credit score is 750 and above.
If you have a low credit score and your loan application goes through, you’ll pay sky-high interest rates. It’s therefore prudent to look at your credit history and figure out how to work on it before you apply.
According to the Fair Credit Reporting Act, you have a right to one free annual credit report from each of the three credit bureaus. You can space out your free credit report from each bureau or request for all of them at once.
Outside of the credit reports by these three bureaus, you can rely on the FICO scoring system that 90% of the lenders look at. However, you will have to get a FICO credit score check.
If you have a low credit score, you can invest in rectifying it through timely bill payment. A low personal debt to credit ratio is also vital in lifting your credit score.
For those who don’t have time to work on their credit, there are bad credit loans available. These loans come with higher interest rates, though, and you should factor that in before applying for one.
2. Business Plan
You’re applying for a loan to start up a business, right? The next thing a financier will look at after your credit standing is the business plan.
Expect questions from the lender around your idea, and it’s viability in the market, of which you should have insightful and clear responses.
If you already have a team to set in place (that increases your odds of success), then you should include their resumes too. No financier will be comfortable handing you a loan if they don’t have confidence in the team that will be charged with animating your idea.
But what about those who need business loans to expand their existing firms? The lender will still want to take a look at your updated business plan to assess your strategy.
It’s from your strategy that a lender can judge whether you can realistically pay back the money.
3. The Age of Your Business
Another critical area of concern for a lender if you have an existing business is its age.
For more traditional lenders, a minimum of six months to two years with you in operation becomes mandatory. So, if you have been legally registered but haven’t begun operations yet, or haven’t operated for at least six months, you will have a tough time.
These lenders gauge the risk they can take on funding your business based on what you’ve been able to accomplish thus far.
For those borrowing money to form a startup, online lenders can be a viable alternative. Such lenders are open to funding ideas based on their assessment criteria.
4. Current Debt and Cash Flow
Many lenders will look for a debt-to-income ratio of 50% or less to feel comfortable greenlighting a business loan.
If you have pre-existing debt that pushes your debt-to-income ratio upwards of 50%, it may be hard for a lender to grant you the credit.
Expect the financier to request your current balance sheet as that helps them determine the financial health of your business.
The cash flow situation of your firm is another critical factor that a lender reviews.
Are you making enough money to sustain repayment? What is the quality of the incoming cash flow? These are some of the questions a lender seeks to answer by inspecting your balance sheet, among other financial documents.
5. Collateral
Most lenders seek to reduce their risk on business loans by asking for collateral – an asset which they can sell to recover the credit. Examples are accounts receivable, equipment, or other easy-to-sell assets.
Asking for collateral also has the dual purpose of ensuring you have skin in the game. The way a leader sees it, if you have your money in the business, you will be more incentivized to make it succeed.
If you don’t have adequate (or any) assets to offer, a lender who thinks your business is sound might ask for a personal guarantee. That means pledging your personal assets to secure the loan.
Study Loan Requirements to Gauge Your Options
It’s a fact of life that your business will, at some point, need external financing. The kind of credit you will look for depends on your firm’s needs. When considering a business loan, you must carefully examine all the business loan requirements to ensure you get attractive terms and avoid straining your cash flow.
Is learning about personal and business finance your passion? Check out more of our content for critical tips, insights, and ideas into how you and our company can become financially healthy.