If you’re ready to start or expand a small business, you may be looking for funding to make your dream a reality. Finding the right loan can make all the difference. Knowing the small business loan requirements can help you choose a lender that’s right for you. This guide explores common guidelines along with specific requirements to expect with each type of business loan. It also dives into business plans and how to make yours stand out to lenders.
The Importance of Understanding Business Loan Requirements
When it comes to securing a business loan, knowledge is power. Understanding the eligibility criteria can greatly enhance your chances of approval as a business owner, whether you’re just getting started or have been established for some time.
For small business owners, it’s vital to understand that requirements may vary based on the lender and the type of loan. While traditional banks may demand a more substantial track record, online lenders might be more flexible with small business loan requirements.
By staying informed about these requirements, you can better prepare your application and increase your approval odds. Doing so also ensures you’re viewed as a credible applicant who is serious about your business’s growth and continued success.
Common Small Business Loan Requirements
You can get a jump start on securing a small business loan by understanding more about small business loan requirements. These requirements differ depending on the loan program and lender you choose. For instance, requirements for an SBA loan may be more complicated than what online lenders require.
Credit
One of the first things prospective lenders will look at when deciding to lend you money for your small business is your credit score. Therefore, your personal credit history will be reviewed by lenders to gauge your creditworthiness, especially if you have yet to establish a business credit history.
If you have yet to seek funding for your small business, you may not be aware of how important your personal credit history plays in your ability to get a small business loan. Lenders see a direct relationship between your personal credit score and your ability to pay loans. It’s important, therefore, to consistently pay bills on time, monitor your credit report regularly for errors, and don’t max out your credit cards.
Be aware that the U.S. Small Business Administration may require a business credit score to qualify for certain loans. If you are just establishing your small business, you may not have sufficient business credit history for an SBA loan.
Amount of Debt
The amount of debt you currently have can have a significant impact on your ability to get a small business loan. Therefore, paying down personal or business debt before applying can put you in a better position from your lender’s perspective.
Cash Flow
Another factor used by lenders when considering your small business loan application is cash flow. Therefore, you need to demonstrate that you can consistently make loan payments. Even if your product or service shows promise and sales are growing quickly, lenders may not be willing to take a risk with your business if you cannot manage unpaid invoices on time.
Lenders typically conduct a cash flow analysis of how money flows in and out of your company, otherwise called your cash flow cycle. While prospective lenders will perform a more complex analysis, you can get an idea of your cash flow by comparing your total unpaid purchases against total sales due at the end of every month. There’s a potential problem if you need to spend more than the cash you will receive.
As a business owner, you should understand the importance of tracking cash flow at all times, not just when you need financing. For example, if your business is new with a lot of start-up costs for equipment or your business is growing quickly, it will affect your cash flow. Likewise, if you have a seasonal business, such as a landscaping or holiday retailer, cash flow analysis can be the difference between business success or failure.
Business Age
One risk factor that lenders consider is how long you have been in business. Depending on the type of small business loan you want, you may be required to have an established business before you apply. Some lenders need proof that you have been incorporated for at least two years for certain types of business loans. However, the requirement for a working capital loan may be less than one year.
Collateral
Another way lenders reduce their risk with small business loans is through collateral. You may be required to identify assets for collateral on your small business loan. That way, if you are forced to default on the loan for any reason, collateral will be used to repay the debt. The value of collateral required could depend on your credit rating, the type of collateral, loan terms, loan amount, and the lender.
Having collateral can improve your loan options. You might use the property for collateral, such as vehicles, commercial real estate, equipment, or inventory. Other collateral can include cash, stocks, bonds, or certificates of deposit (CDs). If your business is new, some small business lenders require personal assets as collateral, including your home or car.
Business Plan
Having a business plan is essential for helping you be strategic about growing a successful business and qualifying for the funding to make it possible. Lenders will look at your business plan to determine how you will use the loan and how you will generate enough income to repay the small business loan.
According to the U.S. Small Business Administration, a business plan is the foundation of your business. It can serve as your guide through every stage of establishing and managing your business. A business plan can be a helpful tool when discussing your business with lenders, investors, customers and collaborators.
What To Include In Your Business Plan
If you are wondering what goes into a business plan, here are six components you may want to include, depending on your business:
- Company description that details the solutions you offer and the competitive advantages that will set your small business apart in the marketplace. Include your mission, leadership team and location.
- Organization and management describe who will run your business and its structure. For example, is the business incorporated as a C or an S corporation, a limited partnership, sole proprietorship or limited liability company?
- The product line or services offered explain exactly what you are selling or what services you provide to customers. You might include patents or copyright information in this section if applicable.
- Market analysis describes your target market and competition in your industry. You must understand trends and challenges your small business will face and convey to lenders how you are positioned to succeed.
- Funding request outlines how much money you are applying for and how your small business loan will be used. Be specific when explaining whether funding will be used for equipment, marketing, salaries, or business expansion.
- Financial projections outline how you intend to use the revenue to make on-time business loan payments. Suppose you are operating an existing business, including the balance sheet, cash flow and income statements. Those will be projections if your business is new.
Types of Business Loans and Their Specific Requirements
When considering a business loan, it’s essential to understand that each type of loan has unique requirements tailored to the loan’s purpose and risk level. Remember, lenders will assess your business’s financial situation, including credit score, annual revenue and potential collateral, to determine if you’re a good fit for funding.
SBA Loan Requirements
The U.S. Small Business Administration (SBA) guarantees a portion of SBA loans, reducing the risk for lenders. To qualify, your small business typically must meet the SBA’s size standards, have a strong business plan, positive cash flow and a
good business credit score. Some SBA programs may require collateral.
Line of Credit Requirements
A line of credit provides your business with flexible access to funds. Online lenders and traditional banks offer these loans.
You’ll need to show a reliable cash flow, a solid business credit score, and, often, some form of collateral. Regular bank statements will be essential to prove your company’s financial stability.
Term Loan Requirements
Term loans are lump-sum loans paid back over a set period.
Lending Requirements include a minimum credit score, usually more stringent for traditional banks compared to online lenders. Lenders will also consider your business’s annual revenue, cash flow, and collateral, making this option more favorable for well-established businesses.
Equipment Financing Requirements
This type of loan is tailored for businesses needing to purchase new equipment without paying the full cost upfront. With equipment financing, the equipment itself often serves as collateral.
Lenders will assess the equipment’s value as well as your credit score and revenue to gauge your eligibility for funding.
Merchant Cash Advance Requirements
A merchant cash advance provides funds based on your future credit card sales. It is an ideal option for small business owners with lower credit scores.
Lenders will evaluate your daily card transactions and cash flow to determine eligibility. This type of loan is typically easier to obtain but may have higher costs, and no collateral is required beyond the card sales agreement.
Conclusion: Preparing for Business Loan Requirements
When you’re gearing up to apply for a small business loan, preparing and understanding the lending requirements can make all the difference.
Start with a comprehensive review of your personal credit score, as this figure often informs a lender’s decision. Aim for a credit score that meets or exceeds the lender’s requirements. Typically, lenders look for a score of around 680 or higher for more traditional loans. But if you apply with an online lender, you’ll typically have more flexibility.
It’s equally important to ensure your financial documents reflect your business’s stability and growth. Annual revenue plays a pivotal role in demonstrating your ability to repay the loan. Most lenders prefer to see a consistent and increasing revenue stream, which lessens the risk from their perspective. So, you want to present organized, accurate records of your earnings for at least the previous two years.
If real estate is involved in securing the loan, understand your equity and the property’s current market value. In this case, lenders may require an appraisal to assess the collateral’s worth against the loan amount.
Most importantly, prepare to provide business and personal tax returns, profit and loss statements, balance sheets, business licenses, legal documents (i.e., articles of incorporation, and a business plan detailing the purpose of the loan and projected financials
By understanding lending guidelines and preparing documentation beforehand, you position yourself as a credible candidate for a business loan. Even better, you can approach lenders with confidence and clear documentation to streamline the lending process.
