If you are an entrepreneur looking to grow, you probably have considered looking into business loans for your small business. Financing can help you take your business to the next level that you could not do without the capital provided by a business loan. If you want to secure the funding, you need to understand the basic requirements that most lenders will ask to get approved.
Requirements of Loans for a Small Business
Lending money is always risky, which is why banks typically look at several factors before committing to a small business loan. In particular, lenders will look for businesses or business owners with good credit, which is made up of the following four components:
- Capital
- Collateral
- Capacity
- Character
Business owners are significantly more likely to be approved for a loan if they have a strong business plan, a decent amount of capital and collateral to back up the loan, a good credit score, and a history of generating profits. Unfortunately, however, many of these things are challenging for small business owners to provide. With four out of five small businesses denied loans from big banks in 2020, the idea of seeking out a loan may seem daunting. Understanding the factors that may prevent your business from being approved for a loan is the first step in finding the financial assistance that’s right for you.
Things That Can Prevent Your Business From Securing a Loan
While some banks will automatically refuse a small business loan, specific factors may contribute to a lender denying a loan. Here are some of the most common barriers small businesses face when seeking funds.
Poor Credit History
Frequently, small businesses do not yet have their credit history to demonstrate that they are safe to loan money to. This means that banks will often have to look at your personal credit history instead. A good credit rating indicates to lenders that you are more likely to pay back your loan on time, making them more amenable to working with you. However, poor credit history can make it incredibly challenging to secure a loan, mainly if there are any negative items on your report.
According to Brian Cairns of ProStrategix Consulting, small business owners should typically aim for a credit score of 720 or above if they want to be considered for a loan. If your score is lower than this, spending time paying down debt and bringing your credit up can significantly improve your chances of obtaining a loan.
Lack of Solid Business Plan
Many small businesses overlook the importance of a strong business plan, a fact which instantly puts off many lenders. Spending the time to draw up a business plan can instantly improve your odds of approval. A good plan will discuss your intended market, your products, and your finances and include a clear summary of your company and its mission. It is also highly beneficial to include a discussion of exactly how you plan to utilize your loan.
Large Debt or Low Income
One of the core components of credit is capacity, which refers to the business’s ability to repay the loan. Small businesses, in particular, are more likely to struggle here, as they are just getting started and therefore may not have a stable income to demonstrate their capacity. They are also more likely to have significant expenses and debt from the costs of setting up the business.
No Collateral
Larger businesses typically already have business infrastructure or equipment that they can use as collateral if they default on their loan. However, small businesses that are just getting started may not yet have this type of collateral. Given the fact that collateral is required for secured business loans, the lack of business infrastructure means that many small business owners need to use their personal home as collateral instead. Choosing this option is risky, as you may lose your home if you default on your loan.
Too Many Loan Applications
Although it may seem like a great idea to save time by applying for many loans at once, this can actually have a detrimental effect on your chances of success. Credit bureaus notice this type of behavior and will often flag it, making you a less desirable candidate for lenders.
Failure to Seek Expert Advice
Seeking guidance from experts such as accountants and retired businesspeople indicates to lenders that you are serious about your business. These experts will be able to provide invaluable information on funding and working capital, thus increasing your chances of financial success. Failure to seek this advice from experts will stand out to lenders and may make them less confident about the future of your business.
Lack of Research of Alternatives
While choosing the first lender that comes your way may seem like a good idea, it can also mean you miss out on opportunities that would be better suited to your business. It is important to research all the options available to you before settling on a final choice. You might start with local lending options or consider options other than a traditional small business loan. There are solutions like an online lending marketplace for businesses that will submit your application to multiple lenders, saving you time and increasing your chances of approval.
Alternatives to Secure a Small Business Loan
If you are struggling to secure a small business loan traditionally, you have several other options to consider. These include:
- Term loans
- Community investment funds
- Lines of credit
Term loans are excellent options for purchasing business essentials such as machinery and equipment. They are fixed-rate, making it easy to budget for your regular monthly payments.
Small business owners who have struggled to secure loans from banks may have better luck with Community Investment Funds, or CIFs. These nonprofit organizations look for local businesses to invest in, gaining all their capital from community members. CIFs are ideal for small business owners who are young, have a low income, or have no collateral.
Another option is to open a line of credit, which is a more flexible loan with a setup similar to a credit card. You can use this money whenever the need arises, so long as you do not exceed your preset borrowing limit. Interest will begin accruing on this money as soon as you borrow it. Once you pay off what you have borrowed, you are free to use the line of credit again.
