Though the business financing industry has changed dramatically as of late, one thing remains the same: banks still offer the most advantageous business loans on the market. Qualifying for a business loan from a bank can give you access to unrivaled rates and terms. The affordability of bank loans, however, makes them very difficult to obtain. Many applicants fail to meet every requirement, or simply don’t meet the most important requirements at all.
Recent data shows that the approval rate for business loans from banks is currently at a record high of 27.3%. But further research found that just 13.9% of banks grant small business owners their signature rates and terms. It seems that a great deal of applicants are unaware of how to obtain the loan of their dreams.
To clear the air, let’s go over the general requirements for a business loan from a bank:
1. Excellent Credit Score
This can’t be emphasized enough. Most banks won’t even look at your application if your personal credit score does not exceed 700, even if you have a thriving business. Steady increases in revenue and profitability will likely not offset a subpar credit score, but excellent credit gives the bank a reason to trust you. Only after this trust is established can the bank move on to your other qualifications.
Aside from timely payments, the most crucial component of excellent credit is a strong credit utilization rate. This represents how much credit you use compared to how much credit is available to you. A credit utilization rate around or just below 30% denotes that you have plenty of credit available but are only using a little of it.
Banks are also partial to applicants that have proven their ability to manage multiple types of credit, like a credit card and business line of credit. Owners of more established businesses should check if the bank will want to see their business credit score as well. Much like your personal credit score, the number one rule for maintaining a great business credit score is to pay your business’s bills on time.
If you’re considering pursuing an SBA loan through your bank, often considered the gold standard of business financing, the business credit scoring qualifications can differ from lender to lender. The FICO SBSS score is used to pre-screen applicants for many major SBA loan programs. Sign up for Nav’s Business Loan Builder to see your FICO SBSS score and get full reports from all three major business credit bureaus before you apply.
2. Strong Cash Flow
Cash flow is a requirement of virtually every financial institution, from banks to online lenders. Since banks offer the lowest rates and highest borrowing amounts, applicants are expected to have exceptional cash flow. This is why banks usually ask for several years’ worth of bank statements and financial statements. They want to see a long track record of upward momentum and consistent income.
What they don’t want to see are periodic dips in revenue or low bank balances. How will you continue making monthly payments during these rough patches? Businesses that are prone to these issues should explore solutions to maintain their bank balances and bring in extra revenue to close gaps in cash flow.
3. Heavy Capitalization
You may have heard the notion that banks only lend to people who don’t actually need the money. This is somewhat true. Banks traditionally favor applicants with so much money in the bank that they don’t need a boost in revenue to make monthly payments. Even if their investment doesn’t go as planned, these applicants could still pay off the entire loan themselves without going bankrupt.
Heavy capitalization would likely play a major role if your business is highly seasonal, or prone to the aforementioned fluctuations in revenue. As long as you have the money to make monthly payments, banks might not mind the occasional rough patch.
Collateral isn’t the mandatory requirement it used to be. Numerous banks now offer unsecured business loans at competitive rates. But like capital, the ability to provide collateral may offset issues fulfilling other requirements.
Equipment, real estate and inventory are examples of assets that can be used as collateral. If you default on the loan, the bank can seize and sell this asset in order to make their money back. In other words, the collateral acts as added security and eases the bank’s concern of losing money.
Let’s say you fulfill the bank’s requirements for annual revenue and time in business but your credit score or cash flow is less than perfect. Both flaws would make the bank hesitant to approve your application. That hesitancy, however, might fade significantly if you put up an expensive asset as collateral.
Required Paperwork and Data
Banks typically require a massive collection of paperwork. With so many financial and legal documents to worry about, it’s easy to forget one or fail to provide the correct information. Applications for business loans from banks are often rejected for this very reason. Here’s a few of the myriad documents required by most banks:
- Personal and business income tax returns
- Personal and business bank statements
- Balance sheet
- P&L report
- Business plan
This last document is one of the most tedious aspects of the application. At 12-15 pages in length, a business plan doesn’t just explain what your business does, how you plan on using the money, and what your investment will do for your revenue.
You must also include an executive summary, market analysis, outline of organizational and management structure, marketing strategy, and more. As you can see, you should set aside ample time to compose your business plan when preparing your application.
Patience is Key
The process of obtaining a business loan from a bank is known for being excessively laborious. When you look at the primary requirements, this isn’t a surprise: it takes time to improve credit, working capital, and cash flow. You could even argue that the most important requirement of all is pure patience. Like any other crucial resource, the most affordable business loans are only reserved for those who take the time to work for them.
This article was originally written on August 5, 2019 and updated on May 12, 2020.