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What is required to get a business loan? More than you might expect. While requirements vary depending on the lender and type of loan, they typically include a minimum credit score, number of years in business, and annual revenue. Many lenders also consider a number of other factors, such as your debt-to-income ratio and the type of industry you’re in, and will ask for a fair amount of paperwork. Read on to learn exactly what banks and other lenders are looking for when deciding who they will lend to, how much they will lend, and what interest rate they will charge, plus tips on how to up your odds of getting approved when you apply for a small business loan.
What Is a Business Loan?
A small business loan is money that is loaned to a small business owner by a bank, credit union, or online lender, and must be repaid. The money is to be used for business purposes (such as operating expenses, equipment purchases, and marketing and advertising) and should not be used for personal expenses. Loan amounts vary, as do repayment periods and interest rates. Fortunately, there are various types of business loans that can accommodate just about every business need you may have.
Why Get or Avoid Getting Business Loans
A small business loan generally shouldn’t be taken out on a whim. Before signing any loan agreement, it can be a good idea to consider both the benefits and drawbacks of taking on business debt.
Pros of Small Business Loans
Cons of Small Business Loans
Can propel your business’s growth
May have to sign a personal guarantee
Allow you to get financing without giving up equity
Interest rates may be high if you don’t have a strong credit profile
Help your company with initial start-up costs or cash-flow issues
Could lose business or personal assets if you default on payment
Some loans don’t require collateral
Many small business loans require making a downpayment
Small and large loan amounts are offered
Monthly payments can limit your budget
Why Do Business Loan Lenders Have Requirements?
Many small businesses fail each year. In order to reduce the risk that comes with loaning money to a small business, lenders generally have a list of requirements.
What Business Lenders Look at:
1. Credit Score
Personal
If your business is new and doesn’t have a strong credit history, lenders will likely look at your personal credit profile. However, this isn’t necessarily a bad thing. If your personal credit score is strong enough, it may get you access to credit for your business that it wouldn’t otherwise be able to get. However, you may have to sign a personal guarantee, which means that if you are unable to pay off the loan, your personal assets could be at risk.
Business
Yes, there are credit scores for businesses, too. As long as you have an employer identification number (EIN) from the IRS, your business will begin developing a credit score. To expedite matters, you may want to open a business bank account and business credit card and register as much as you can in your business’s name.If you pay your business’s bills on time and keep its debts low, you can help your business build a strong credit profile. The stronger your business’s credit, the more likely banks will lend to you at an attractive rate and without a personal guarantee.
2. Revenue
A business with a strong, predictable revenue stream has a good chance of getting approved for a high loan amount with a low interest rate. If you’re just starting out and your monthly revenue is still picking up steam, you may have trouble taking out certain types of business loans. In fact, it’s common for lenders to advertise business loan requirements dictating what your monthly revenue needs to be in order to qualify.
3. Debt-to-Income Ratio
Debt-to-income ratio (DTI) shows how much of your small business’s monthly earnings go to repaying your existing debts. Lenders look at DTI because it helps demonstrate how affordable new debt repayments are likely to be and your business’s likelihood to meet those commitments.DTI is normally shown as a percentage. To calculate your company’s DTI, you simply add up all of your monthly debt repayments, then divide this amount by your business’s monthly gross profits. Multiply the result by 100 to get your DTI ratio percentage. To be considered for a loan, your DTI ratio should be below 50 percent. To improve your chances of loan acceptance, aim for a DTI ratio of 36 percent or less.
4. Business Plan
What do you intend to use the money for? How do you anticipate it will increase your company’s profits? Some loans (including traditional term loans and SBA loans) require you to submit a business plan or loan proposal as part of your application. This can be a great opportunity to show your lender that you’ve thought through all the potential opportunities and challenges for your business and how you’re going to grow a successful company.
5. Collateral
Lenders often require borrowers to put up a fixed asset (like property or equipment) to secure the loan. This reduces risk for the lender because, should you default on the loan, they can seize your collateral and sell it to make up for some of the money they’ve lost. If you’re applying for an SBA loan or bank loan, for example, lenders will want to know what kind of collateral your small business has to offer, and the value of that collateral.Not all loans require collateral though. As you explore small business loans, you’ll find ones that don’t, which are called unsecured loans. However, in place of collateral, the lender may require a personal guarantee or charge higher interest rates.
6. Time in Business
The magic number many banks want to see is often two years. It’s not uncommon for a new business to fail shortly after they’ve opened, so the fact that you’re still standing after two years is a good sign to a lender.However, if you haven’t been in business for two years, this doesn’t mean you won’t be able to get a loan. You may have trouble with some of the more traditional options — such as SBA loans and bank loans — but online lenders will often have more flexible requirements with regard to your time in business.
7. Industry
Every industry has a level of risk, so lenders will want to know what type of business you own when considering your eligibility. In addition, some lenders have certain industries that they won’t lend to (such as firearms businesses) that could affect their reputation. Others have less obvious restrictions, so it’s a good idea to check with a lender regarding any ineligible industries before submitting your application. You’ll also want to be sure you correctly identified your business’s industry in your loan application. There are two main industry code systems: Standard Industrial Classification (SIC) and North American Industry Classification System (NAICS). The application will guide you on how to look up your code.
8. Bank Statements
Many lenders will ask for at least four months of bank statements during the underwriting process. They do this to make sure the claims you are making about your company’s financial history are accurate, and make sure you’ll be able to afford the loan payments. These statements also give them insight into how well you are managing the money that is coming into the business each month.
9. Business License and Permits
Business licenses vary by state and industry, but a lender will want to see proof that you are the owner and are legally allowed to run your business. You may also need to supply any relevant permits, such as sign permits, zoning permissions, fire permits, sales tax, and health department permits.
10. Loan Amount
A lender will ask you to specify how large a business loan amount you want to take out. Large commercial banks tend to offer the largest loans, as much as $1 million and more. If you’re in need of a smaller amount of capital (say $250,000 or less), you may be better off with an SBA loan, online term loan, or microloan. Before you submit this loan requirement, you’ll want to think carefully about what you will use the loan for (such as expanding your business, start-up costs, etc.), then come up with a detailed budget that includes all the expenses involved. You may also want to add a small cushion to cover any unexpected expenses.
11. Loan Purpose
A loan purpose is similar to your business plan. The only real difference is that you’ll answer this question on the loan application itself. When stating your loan purpose, you’ll want to be as specific as possible. This shows the lender that you have a very specific plan for the money, and it may even lead them to introduce different loan products that are more suitable for your needs, such as business loans for LLCs.
12. Down Payment
Depending on your loan type and other qualifications, you may be required to make a down payment to get a business loan. For example, bank loans and SBA loans typically require you to put 10% to 20% of the loan principal down in order to secure the loan.
13. Other Factors
Lenders may ask for a number of other documents during the application process, including:
Your personal and business tax returns
Accounts receivable and balance sheets
Proof of collateral
Copy of your commercial lease
Disclosure of other debt
Legal contracts and agreements
How to Increase Your Chances of Getting a Small Business Loan
To improve the odds that you’ll get approved for a loan, it’s important to understand how business loans work. Below are some simple things you can do to present a strong application.
Put up collateral. By offering collateral, you lower the risk for the lender. While it's not a guarantee, it can increase your chances of getting a loan approval.
Pay off your debts. If your DTI is high, it indicates to a lender that you're using a lot of your income to pay off other loans. That's a sign of risk for any lender, so it can be a good idea to pay off some of your other debts before applying for a loan.
Work on building a better credit profile. The minimum credit score needed to qualify for a business loan will vary by lender. But, generally, the stronger your personal and business credit, the higher your chances of getting approved for a business loan.
Choose the right lender. Not all lenders have the same requirements. If you have thin or poor credit, for example, you will likely stand a greater chance of getting approved for a business loan with an alternative, online lender than with a traditional bank.
Wait a year or so. If your business hasn’t been around for at least two years, you may want to hold off applying for a loan and put your efforts into building a strong foundation for your business and increasing your revenue. This will make it likely that you’ll be approved for a loan in the future.
The Takeaway
Small business lenders typically have a long list of requirements for a loan. But that doesn't mean you can’t get one. What it does mean is that you will likely need to do some preparation before you apply for a loan, including thinking about how you will use the loan, determining how much you will need, assessing your company’s financials, and collecting all the necessary documents.If you’re interested in finding out what type of loan your business may qualify for, Lantern by SoFi can help. With our online comparison tool, you can instantly get access to small business financing options matched to your company’s needs and qualifications.
Frequently Asked Questions
Do business loans require down payments?
Do business loans require personal guarantees?
How much deposit is required for small business loans?
What is good business credit?
Photo credit: iStock/jacoblund
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
