Understanding what lenders require before applying for a small-business loan can simplify the process and set you up for success. Securing a loan can be time-intensive, but being prepared with the right information reduces frustration and increases your chances of approval.
Finding the best place to get a business loan depends on your financial situation, business needs, and credit profile. Traditional banks, online lenders, and government-backed programs each have unique requirements, so knowing what to expect can help you choose the right lender and streamline the application process.
1. Personal and Business Credit Scores
Your credit score plays a pivotal role in determining loan eligibility. For traditional bank loans or government-backed SBA loans, a strong personal credit score—typically 690 or higher—is crucial. Excellent business credit can further enhance your approval chances.
However, online lenders are often more flexible, focusing on your business’s cash flow and overall track record. Some even offer options for those with lower credit scores, accepting personal credit scores as low as 500.
Why Credit Scores Matter:
Lenders evaluate personal credit to understand how you handle debt, such as credit cards or mortgages. Established businesses may also have business credit scores, ranging from 0 to 100, which are assessed by bureaus like Experian, Equifax, and Dun & Bradstreet.
Quick Tips to Improve Your Credit:
- Dispute errors on your credit report.
- Pay bills on time and in full.
- Build business credit by responsibly using trade credit and keeping public records clean.
2. Annual Revenue
Lenders want to ensure your business generates enough revenue to cover loan payments. Minimum revenue requirements vary widely: for instance, OnDeck requires $100,000 annually for its line of credit, while Bank of America sets its threshold at $250,000 for secured loans.
If your revenue falls short, consider alternative financing options like invoice factoring, which allows businesses with lower revenue to secure funding.
Understanding DSCR:
Debt service coverage ratio (DSCR) is another metric lenders might evaluate. This ratio compares your operating income to your total debt obligations. A ratio above 1—ideally 1.25 or higher—indicates that your business can comfortably handle its debts.
Example Calculation:
If your annual income is $150,000 and your debt payments total $100,000, your DSCR is 1.5.
3. Years in Business
Your time in business reflects your company’s stability and likelihood of repayment. Most traditional banks and SBA lenders require at least two years of operational history. Online lenders may have more lenient requirements, often approving businesses with as little as six months of operations.
Startups without a long history may need to rely on alternative funding sources or present a detailed business plan to demonstrate potential.
4. Business Industry and Size
The nature and size of your business can affect your eligibility. Certain industries—such as restaurants and beauty services—are often considered high risk due to inconsistent revenue streams.
SBA Loan Industry Guidelines:
To qualify for an SBA loan, businesses must:
- Meet the SBA’s definition of a “small” business, which varies by industry.
- Operate as a for-profit entity.
- Avoid disqualifying activities, such as real estate investing, gambling, or lobbying.
- Be current on all government loans, with no history of defaults.
5. Business Plan and Loan Proposal
Lenders want assurance that their funds will be used wisely and repaid reliably. A solid business plan outlines your goals, strategies, and financial forecasts, while a loan proposal details the purpose of the loan and your repayment plan.
These documents demonstrate your financial health and build lender confidence. For startups, a thorough business plan can compensate for a lack of revenue history by showcasing growth potential.
6. Collateral or Personal Guarantee
Many loans require collateral—assets such as equipment, real estate, or inventory that the lender can seize if payments aren’t made. SBA loans over $50,000 often require collateral and a personal guarantee, meaning your personal assets may also be at risk if the business defaults.
Some lenders offer unsecured business loans that don’t require physical collateral but may impose stricter terms or higher interest rates. Others may take a blanket lien on your business assets, giving them the right to seize various assets to recover their funds.
Key Questions to Ask:
- What types of collateral are accepted?
- Will a personal guarantee be required?
7. Business and Financial Documentation
Traditional lenders often request extensive documentation to evaluate your loan application. Essential documents include:
- Personal and business tax returns.
- Profit and loss statements.
- Balance sheets and cash flow statements.
- Bank statements (personal and business).
- Business licenses and articles of incorporation.
- Proof of collateral (if required).
- Legal contracts or agreements.
- A detailed business plan.
Avoid Common Mistakes:
Submitting outdated or incorrect information can slow down the application process or result in rejection, especially if the lender uses automated underwriting. Double-check all forms and consider having a financial professional review your application before submission.
Tips for a Smooth Application Process
To improve your chances of approval, follow these steps:
- Prepare Early: Gather your financial and legal documents in advance.
- Be Accurate: Ensure all information is current and error-free.
- Consult an Expert: Seek advice from a business advisor or financial professional.
Online lenders often have simpler application processes, requiring fewer documents and offering faster approval times. However, traditional banks may provide more favorable terms if you meet their stricter requirements.
8. Purpose of the Loan
Lenders often require a clear explanation of how you intend to use the loan. Whether it’s for purchasing equipment, expanding your operations, or improving cash flow, having a well-defined purpose demonstrates responsibility and strategic planning.
Your loan purpose helps lenders assess the potential risk and viability of your request. For instance, funding a revenue-generating project may appear less risky compared to covering operational deficits. To strengthen your application, provide a breakdown of how you’ll allocate the funds and the expected outcomes.
Tips for Defining Your Loan Purpose:
- Be specific about how the loan will benefit your business.
- Align your loan purpose with your business goals and growth strategy.
- Use realistic projections to show the impact of the funding.
A well-documented purpose reassures lenders that the loan will be used effectively and increases your likelihood of approval.
9. Debt-to-Income Ratio
In addition to evaluating your business’s revenue and DSCR, lenders may look at your personal and business debt-to-income (DTI) ratios. This metric compares your total monthly debt payments to your gross monthly income and helps lenders determine if you can manage additional debt.
For business loans, a low DTI ratio indicates that you’re not overleveraged and have the financial flexibility to take on new obligations. While acceptable DTI ratios vary, many lenders prefer them to be below 50%.
How to Calculate Your DTI Ratio:
Divide your total monthly debt payments by your gross monthly income and multiply by 100. For example, if your monthly debt payments total $4,000 and your gross income is $10,000, your DTI ratio is 40%.
Ways to Improve Your DTI Ratio:
- Pay down existing debts before applying.
- Increase your revenue streams or reduce expenses.
- Consolidate high-interest debt for lower monthly payments.
By maintaining a healthy DTI ratio, you not only improve your loan eligibility but also demonstrate strong financial management to potential lenders.
Final Thoughts
Applying for a business loan can feel overwhelming, but understanding the requirements makes the process smoother and boosts your chances of success. By maintaining strong credit, preparing accurate and up-to-date documentation, and clearly defining your loan purpose, you demonstrate reliability and strategic planning to potential lenders.
It’s also important to evaluate financial metrics like your debt-to-income ratio and ensure your business is positioned to manage additional debt responsibly. Whether you’re applying for a traditional bank loan, an SBA loan, or an online business loan, preparation and attention to detail are key.
The effort you invest in understanding and meeting these requirements can pay off in securing the funding you need to achieve your business goals and drive growth.
