A small business loan is a form of financing that provides an injection of capital to a business, often to finance an expansion or resolve short-term cash flow problems.
There are various types of business loans, such as business term loans and startup loans. Some business financing tools can be used for general purposes, such as in the case of business credit cards, while others can only be used for narrowly defined purposes, such as in the case of equipment loans.
Business loans are often provided by traditional banks, and if you have a more established business with healthy cash flow, this may be your best bet. There are also several alternative solutions, including online lenders, that can cater to businesses that don’t meet the criteria for traditional loans.
Whichever loan might be right for your situation, the first step will be to familiarize yourself with the eligibility requirements and the steps you need to take to get approved.
What do you need to get approved for a business loan application?
Business loan requirements are the criteria you must meet to qualify for these products. If you are considering a loan for your small business, you should familiarize yourself with the qualifications you will need to meet and the steps you will need to take to get approved for financing.
Credit
Lenders typically check your business credit score to determine your eligibility. Unlike personal credit scores, which range from 300 to 850, a business credit score ranges from 1 to 100. You should aim for a score between 80 and 100 to get the best rates.
Many lenders will also look at your personal credit score before making a decision, especially if you have a small business, sole proprietorship or startup. (You should have a credit score of at least 630 to 650 to increase your chances of getting approved for financing.)
Income
Lenders prefer to do business with profitable companies that have sufficient liquidity to meet their loan obligations. Even if a company generates high revenues, low or negative profit margins can make it difficult to service its debts.
It is common practice for lenders to require businesses to demonstrate a minimum annual turnover in order to qualify for a loan. However, specific requirements and thresholds vary between lenders and loan types.
An established business
Data collected by the U.S. Small Business Administration shows that only about half of all small businesses survive longer than five years. The same data shows that over 30% of small businesses fail within two years. Given these statistics, it should come as no surprise that lenders prefer to work with established companies.
Early startup stage businesses are generally riskier than more mature businesses because they are more likely to default on their debt obligations. If your business has been in operation for less than six months or two years, you may have difficulty obtaining financing with a loan. However, time-in-business requirements vary by lender, and alternative lenders generally have more flexible eligibility criteria.
Even if your business is established enough to qualify for loans, you may not qualify for the most competitive rates. Older businesses typically receive more favorable terms, such as lower interest rates and higher credit limits, than younger businesses.
Personal guarantee
When making a loan to a small business, most lenders require a personal guarantee from any partner in the business who owns at least 20% of the business. This is a commitment to repay debts if the business falters and means the individual’s assets are potentially at risk in a worst-case scenario.
A business plan
Lenders want to know what your business does and how you plan to achieve your goals, which is why you will typically be asked to present a business plan in the loan application process. This document will include details about your strategy and an analysis of the opportunities for your business. A business plan generally details operational needs, as well as revenue and cost data and projections.
Collateral
If you are applying for a secured business loan, you will need to provide collateral, such as equipment, inventory or real estate, to protect the lender. If you stop making payments on your loan, your collateral may be seized to cover your debts.
What are your options if you have bad or no credit?
Securing a business loan will be more difficult if you have bad or no credit. However, it is not an impossible feat. These are some of the options if you have bad or no credit:
- 30 net accounts: Net 30 accounts are a common entry point for businesses with no credit history. Some sellers offer a 30-day interest-free loan on business purchases. Often, these providers will report your payment history to major business credit bureaus, allowing you to build a credit score for your business so you can access other forms of financing in the future.
- Invoice factoring: Invoice factoring allows you to sell your company’s unpaid invoices to third parties who then collect payment. Since the factoring company collects personally from the customer, they will focus on the customer’s creditworthiness and not yours. Invoice factoring can give you quick access to funds, but it can potentially damage customer relationships and won’t raise your credit score.
- Secured loans: Secured loans secure your loan with some form of collateral. We’ll cover this topic in more depth in the next section, but it’s worth noting that many lenders have more relaxed credit score requirements for this type of loan.
- Alternative lenders: Large, traditional, established lenders, such as Citigroup and Bank of America, typically have more stringent lending requirements. Alternative lenders, on the other hand, target businesses that cannot benefit from traditional loans. They typically have more flexible loan terms and requirements, which can be beneficial to early-stage businesses. In exchange, these lenders may charge higher interest rates and fees.
What documents are needed to get a business loan?
When you apply for a business loan, your lender will ask for certain documents to verify your identity and assess the financial health of your business. While specific requirements may vary by lender and loan type, most will require similar documents.
Here are some of the most commonly requested documents for a business loan:
- Any applicable business licenses
- Commercial leases
- Balance
- Driver’s license or other personal identification document
- Constitutive Act
- Contracts with third parties
- Business plan
- Cash flow estimation and budget
- Bank statements
- Tax returns
- Credit reports
- Financial history statements
- Tax declaration
What is the difference between a secured and unsecured business loan?
The main difference between a secured business loan and an unsecured business loan is that secured loans are backed by collateral, while unsecured loans are not. If you default on a secured loan, the lender will take possession of the listed collateral. Warranty can come in many forms, including:
- Heavy equipment
- Vehicles
- Real estate
- Unpaid invoices
Some types of loans are built with a specific form of collateral in mind. For example, lenders usually have more lenient policies for equipment loans, which are secured by the financed equipment.
Unsecured loans are not backed by specific collateral. However, that doesn’t mean lenders can’t chase you for any unpaid loan balances. When you sign a personal guarantee, you give lenders the right to pursue you personally for the unpaid loan balance if your business defaults on payments, even if your business is organized as an LLC.