No matter what kind of business you run, you will eventually require funding to keep things running. This implies that in order to increase your operating capital, you will need to apply for a business loan from several lenders. It’s something that many business owners do annually.
Unfortunately, if you don’t know what lenders demand from you, the loan application procedure may be rather difficult. To get approved for a loan, you may need to fulfill certain requirements set down by some lenders.
This article aims to provide you with some knowledge and insight into the common criteria and conditions associated with small business loans.
1. Business Industry and Size
Each industry has a varying amount of risk, and some have more risk than others because of the likelihood of irregular revenue such restaurants and beauty services.
In certain cases, lenders completely avoid working with particular sectors. These usually include businesses that provide money services, adult entertainment, gambling, and product or drug marketing.
There are regulations associated with U.S. Small Business Administration government-backed loans. The SBA defines “small” business differently depending on the sector, and your company must fit this description. In order to know how to qualify for small business loan, you can check the same on the guidelines issued by the government.
All federal debts must be current with no prior defaults; for example, you will not be eligible if you have ever been late (not made your payment within 90 days of the due date) on a federal education loan or a government-backed mortgage.
2. Personal and Business Credit Scores
To be eligible for a regular small-business loan or an SBA loan guaranteed by the government, you’ll probably need outstanding company credit or good personal credit (usually a score of 690 or above).
On the other hand, online lenders can be less stringent when it comes to credit ratings and instead place more emphasis on your company’s cash flow and track record. Even with a 500 minimum personal credit score, several non-profits and internet lenders provide business loans for borrowers with poor credit.
Credit scores are a measure of your capacity to pay back personal loans, including mortgages, credit cards, and auto loans. A personal credit check is required by small-business lenders since they are interested in your debt management skills.
3. Debt-to-income Ratio
Another tool used by lenders to assess the creditworthiness of your company is the debt-to-income (DTI) ratio. A DTI ratio, in its simplest form, compares your company’s monthly debt to its gross revenue.
DTI for your company is computed by dividing monthly debt payments by total revenue. For an illustration, look below:
If your business’s monthly debt is $45,000 and gross income is $65,000, divide $45,000 by $65,000 for a DTI of 69%.
Overly high DTI ratios may also be a sign that your company is having trouble paying down its debt. Keeping your debt-to-income ratio below 43% will assist in attracting lenders to your company.
4. Business Plan
A thorough and accurate business plan is essential; potential lenders may want to know why you are seeking a loan and how you intend to utilize it to boost revenue. Moreover, including the strategy in your application makes your company stand out from the competition.
Every important piece of information about your firm, including its description, management, product or service offerings, current financial statements, and marketing and sales plan, should be included in your business plan. The proposed plan must show that the desired loan will be sufficient to pay for your costs as well as other loan repayments.
5. Annual Business Revenue & Profit
The income and profit of your company are essential factors in determining its creditworthiness. Financing can be substantially more difficult for fledgling enterprises since they lack significant evidence of sales income.
To be eligible for a business loan, many lenders want six figures in sales annually. You may need to look into other funding sources if your company doesn’t generate much cash flow.
Similarly, it might take a long time for your profits to raise your eligibility for small company loans since many enterprises require two to three years to generate a profit. In any case, be careful to maintain precise bank statements and records.
Demonstrating your annual profits throughout the loan application procedure is easier if you have the right paperwork.
6. Documents Needed for a Business Loan
Obtain the necessary paperwork before applying for a small business loan. A lender will probably require any or all of the following:
- Bank records
- Business and individual tax returns
- Licenses and permits for businesses
- Employee Identification Number (EIN)
- Proof of collateral
- Balance sheet
- Copy of your commercial lease
- Disclosure of other debt
- Accounts payable and accounts receivable aging
- Ownership and affiliations
- Legal contracts and agreements
- Your driver’s license
- Business insurance plans
- Payroll documentation
- Documents of incorporation
- Business plan
Before applying, visit your lender’s website or contact them to find out if more papers are needed.
Conclusion
Getting a small business loan requires a few important elements. Your personal and corporate credit ratings must be high to avail yourself of a business loan. Moreover, it is essential to provide a detailed strategy outlining your intended use of the loan and evidence of your company’s profitability when applying for a loan.
Keep your debt-to-income ratio in check and be aware of whether your company is operating in a risky industry. Ensure all necessary documentation, such as financial statements and tax records, is available.
Certain lenders may require your company to generate a specific quantity of revenue. By doing these things, you can improve your chances of obtaining the loan you require to support the expansion of your company.