This post was reviewed and updated on June 24, 2020
If you’re applying for small business financing (or thinking about it), no doubt you want your application to be approved. That’s where business loan requirements come in. The better your application matches the lender’s small business loan requirements, the better the chance you’ll get the loan you want. Here we break down the most important factors and offer strategies for getting the financing you need.
6 Most Important Business Loan Requirements
As you review your loan options and apply for a new business loan, keep in mind that these are among the main factors lenders may consider:
- Credit scores
- Time in business
In addition, depending on the type of loan, a couple of other important factors small business lenders may take into account include:
Let’s break these down even further.
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In business finance, lenders may look at your personal credit scores, business credit scores or a combination of the two. According to research from the Federal Reserve (SBCS, employer firms 2019), just over half of business owners used either a business credit or a combination of personal and business credit when applying for financing. The rest only used personal credit.
Keep in mind that if there is a personal credit check, the lender will likely require it for any owner with 20% or more ownership in the company— not just the individual filing out the application. So if one of the owners has a bad credit history you want to make sure you address that as soon as possible. (If the loan application requests a Social Security number there’s a good chance that personal credit will be checked.)
Both types of credit scores can help lenders assess risk. A good or excellent score indicates healthy financial habits, like on-time bill payment and low credit utilization. A poor credit score can indicate that a borrower has failed to meet their repayment obligations and therefore may fall behind again in the future.
Why do business lenders check personal credit for small business loans? There may be a few reasons:
- The applicants are required to sign a personal guarantee, agreeing to be personally responsible for the debt if the business doesn’t pay.
- The business hasn’t established business credit or does not have a business credit score.
- Personal credit scores are used to gauge the “character” of the borrower in terms of how they manage their finances.
If a small business loan application requires a social security number, it’s likely the lender will be pulling personal credit. It’s worth noting that personal credit checks for small business loans may be “soft” credit checks which don’t impact your credit scores.
If your personal credit scores aren’t strong, be prepared to provide an explanation, particularly if there were extenuating circumstances (such as an illness not covered by insurance.) It’s not clear yet how lenders will take into account financial setbacks due to COVID-19, but if you monitor your credit scores on a regular basis you may be able to provide evidence of previous good credit that was impacted by the crisis.
Though there are a number of places to get personal and business credit scores, Nav is the only place where you can get and monitor both your personal and business credit scores for free.
What’s a typical required minimum credit score? That depends on the lender and the type of loan you need. For instance, you’ll likely need good to exceptional (680 – 850) personal credit scores, and good business credit scores if you plan on getting financing through a traditional lender like a bank, or if you’re seeking a long-term working capital loan or business acquisition loan. Note that some lenders who check business credit don’t use a business credit score. Instead they check for UCC filings or for derogatory items such as collection accounts, liens or judgements.
Most Small Business Administration (SBA) loan requirements don’t include a minimum credit score, but individual SBA lenders may impose their own credit score requirements. When they do, a minimum score of 680 is common. Certain SBA programs, such as PPP loans, EIDL and microloans may be more flexible when it comes to credit scores.
Other business financing options, particularly those through online lenders, may be available to borrowers with fair to poor credit. You’ll probably pay more for these loans, but they may be available based on revenue and cash flow, rather than credit scores.
Time in business
There’s no hidden meaning here. The “time in business” requirement refers to the age of your business, and many lenders prefer to work with businesses that have been open for a specific length of time. It’s a fact that many small businesses fail. The longer your business has been around, the less risky it is simply by virtue of the fact that it is still operating.
In the past, it was common to see lending requirements that specify a minimum of two years in business. Thanks to the coronavirus, we may see lenders extending that to a longer period to account for these unusual times. Time will tell.
Tip: Watch out for companies that promise to sell “aged” corporations for a large fee. There’s no guarantee they will help you get financing quickly and easily.
If your business is less than a year old (or two years old in some cases) it probably will be considered a “start up” and you’ll have to find a start up loan. These may include:
- Business credit cards
- Retirement loans
- Personal loans
If your young business has strong revenues, other options may include merchant cash advances or invoice factoring.
You’ve heard the axiom, “Banks don’t want to lend money when you need it?” To some extent it’s true. Lenders generally aren’t in the business of investing in business ideas. That’s a job for angel investors, venture capitalists and private investors. Instead, lenders want to lend money with a reasonable expectation that they will get paid.
For obvious reasons, a lending institution will be hesitant to extend a small business loan if a borrower’s revenue isn’t adequate enough to make minimum loan payments. Credit reports don’t contain reliable information about revenues, so to verify revenue, lenders may ask for any combination of the following:
- Business tax returns for the past two or three years
- Business bank account statements for the past 3-6 months
- Access to the business bank account to analyze revenues
- Access to the merchant account to analyze credit and debit card sales
- Personal tax returns (especially for bank loans or personal guarantees)
If you are trying to get a small business loan and you don’t have a business bank account, you’ll probably have trouble getting approved. It’s going to be nearly impossible to separate business activity from personal activity in a personal account. It can also be problematic if you pay personal expenses from your business account. If that’s how you’ve been operating, it’s time to change.
It’s more important than ever to separate your business and personal finances to give your business the best shot possible at loan approval. Always use a business account for business transactions and a personal account for personal ones.
How much do you need to bring in each month? That depends on the lender. Some look for as little as $50,000 annually, which is just shy of $4,200 monthly. Others look for annual revenue numbers of $100,000 or more. As always, consult potential lenders for revenue specifics, and remember that there are funding options for start-up businesses, so don’t get discouraged.
At a minimum you should know your total revenues for the past year, as well as your average monthly revenues for the past year, six months and three months. If you don’t, talk to your accountant.
In addition, when analyzing revenues, lenders may analyze the following factors:
- Are revenues increasing or significantly decreasing?
- What are the average monthly revenues for the last 3/6/12 or 24 months?
- Are revenues diversified? Or is the business reliant on a single customer or two?
- Does the business bank account show NSFs (non-sufficient funds) on a regular basis?
- Does the bank account show low balances (the actual threshold varies) or NSFs (non-sufficient funds) on a regular basis?
Lenders generally target (or exclude) businesses in certain industries. To determine those industries, they will often review the SIC or NAICS code of the business. The Standard Industrial Classification (SIC) code or its newer cousin, the North American Industrial Classification Code System (NAICS) assigns an industry code to the business. (NAICS codes replaced SIC codes in 1997 so they are more common, but you may still see instances where an SIC code is used.)
Your NAICS code may be listed on your business credit reports. Make sure you check your business credit reports to find out what they list here, and to make sure it’s accurate. The list of restricted industries varies from lender to lender, in both number and type, but if your business falls into one of the categories on your preferred lender’s list, you may need to look to another lender or funding option.
For certain types of small business financing, your business financials may be an important part of the decision. Because revenue only tells one side of the story—i.e., how much is coming in—lenders may also analyze your cash flow, which indicates how money moves into and out of your business.
To determine if your revenue and cash flow meet their underwriting requirements, lenders may ask for financial statements as part of the loan application process. These may include balance sheets, which look at your assets and liabilities (e.g., real estate loans, vendor credit, etc.), as well as your bank statements and tax returns.
Tip: Keeping your bookkeeping up to date, and having a good relationship with your accountant can be very helpful when you’re trying to get a small business loan.
Debt to income ratio
Some lenders will evaluate your debt to income ratio (DTI) which compares your total monthly debts (e.g, credit cards, mortgages, etc.) to your total monthly income. Typically presented as a percentage, this number is often used to determine if you can afford to take out a loan and, if so, how much you can afford to borrow. To determine your DTI, you can use the calculation below.
DTI = Total Debt/Total Income
A lender may also look to your debt service coverage ratio (DSCR), which is similar to DTI but used to evaluate your business expenses as they relate to your net annual income. Included in your DSCR is your operating income as well as any debt obligations for one year.
To calculate your DSCR, you can take your net operating income and divide it by your total debt obligation, also known as your total debt service.
DSCR = Net Operating Income/Total Debt Service
A DSCR of 1 or higher means your business can cover expenses. A DSCR below that means that you’ll likely need to rely on outside funds to cover a portion of your debt or operational expenses.
There’s no hard and fast rule when it comes to the perfect DTI or DSCR. Generally, you want your DTI to be somewhere below 43% — the lower the better. Conversely, a higher DSCR number is more favorable, and generally, experts recommend that you have a DSCR of 1.10 or higher, though this too can vary from lender to lender.
A secured loan is backed by collateral, usually liquid assets that can easily be converted to cash, like CDs, stocks, bonds, real estate, equipment, or automobiles. If you fail to meet the repayment terms, the lender can seize the asset in lieu of payment. (An unsecured loan, on the other hand, requires no collateral.)
In some cases, like equipment financing or commercial real estate loans, the loan is collateralized by the very thing it’s being used to purchase. If you fail to make payments on your equipment, the lender can seize the equipment. If you fail to make your commercial mortgage payments, the lender will put a lien on your property.
In other cases, you’ll need to have collateral approved by the lender. For instance, if you’re financing a big business purchase or seeking a long-term loan, a lender may require collateral. If you don’t have hard assets to pledge keep in mind some lenders will instead file a UCC filing against “accounts receivable” of the company. Collateral may also include inventory or even “general intangibles.”
How much collateral you need depends on several factors, including your credit history, loan amount, and the purpose of the loan (e.g., access business acquisition funding, cover start-up business costs, manage seasonal cash flow needs).
Where Can You Find Business Loan Requirements?
As mentioned above, each lender has their own set of business loan requirements, and the best way to find out if you’re eligible for financing is to visit the lender’s website or contact them directly. Questions on the loan application may provide clues as well. If t a lender doesn’t ask for your SSN, for example, it probably won’t be looking at personal credit scores.
Some lenders provide helpful insights before you apply, and others will simply encourage you to apply. If you have specific concerns about the requirements of a loan (such as credit scores) try to be specific with your questions, for example: “Do you approve applicants with a credit score of 650?”
Generally speaking, if you’re considering a small business loan through a traditional bank or credit union, you will likely need to have two years of business under your belt, have a DTI below 43%, and a DSCR above 1.10. You’ll also likely need annual revenue of at least $50,000 – $150,000 and good to excellent credit.
If, however, you’re considering a cash flow loan loan through an online lender, you may find that some have more flexible business loan requirements, specifically as it relates to your time in business, annual revenue, and credit score.
Further, some funding solutions, like certain equipment financing loans, often accommodate borrowers who don’t have great credit or wouldn’t otherwise meet the business loan requirements of traditional lending institutions. That’s because they can repossess the collateral if needed.
Find Your Match
Another way to find the right small business loan is to let technology do the work for you. With a free Nav account you can get personalized financing recommendations — filtered and ranked — from over 110 business credit cards, lines of credit, SBA loans and more. You don’t have to know each lender’s requirements because behind the scenes Nav will help match you to loans that are the best fit based on your qualifications and lender requirements.
Want to learn more about how you go from application to funding? Check out our article on how business loans work.
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Pro tip: What you don’t know can kill your business
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