What Are the Most Common Requirements to Apply for a Business Loan?
Mon | July 2023
In 2021, 59% of small businesses had fair or poor finances, says the Federal Reserve Banks' Small Business Credit Survey.
Also, only 42% of small businesses got all the funding they needed. This shows a big gap in financial support. This stat shows the economic challenges small businesses faced during COVID-19. These challenges still affect many today.
As small businesses navigate limited access to financing and ongoing challenges in the wake of the pandemic, understanding your options for business loans is more important than ever. This article will cover the key requirements for applying for a business loan. We will also explore the most common types of business loans.
With this knowledge, you'll be better prepared to find the right financing for your business. You'll also be ready to secure the capital needed to grow and thrive.
Understanding Business Loan Requirements
Business loan requirements can vary depending on the lender and how you plan to use the funds. However, there are some common criteria you can expect when applying for a loan. Understanding the following requirements can help you prepare and improve your chances of getting the financing you need.
1. Business Plan and Loan Proposal
Think about stepping into a restaurant and trying to order without even a peek at the menu. Sounds odd, right? The same goes for approaching a loan application without a well-prepared business plan and proposal - it's simply not advisable.
Consider your business plan as your venture's detailed 'menu.' It should holistically present your business goals, yearly revenue, strategies, target audience, and comprehensive competitor analysis.
This blueprint should also carry your financial projections, ideally for three years. This displays your financial acumen and indicates your readiness to navigate your business's future financial course.
Take your loan proposal too. This key document should unmistakably lay out why you need the loan. Whether to acquire new machinery or broaden your business reach, being clear and detailed in your proposal can greatly boost your chances of bagging that loan.
2. Credit History
Strong personal and business credit scores significantly increase your chances of securing a loan. Typically, a personal credit score of 690 or above is needed to qualify for a government-backed SBA loan or a traditional bank small-business loan. Funders check this score to see how you manage debt. FICO scores, widely used in lending decisions, range from 300 to 850, and the higher the score, the better. If you want to check your credit score, you can get it for free credit from platforms like Experian USA.
However, it's not just your personal credit history that matters. Business credit scores also come into play, typically ranging from 1 to 100. Don't worry if you don't have a business credit yet. You can start building it today by separating your personal and business finances. Begin by registering your business, getting a federal EIN, and opening a business bank account. Make sure to work with suppliers who report your timely payments.
Online funders tend to be more lenient with credit scores, focusing more on your business's cash flow and track record. For example, One Park Financial requires a minimum personal credit score of 500. So, while solid credit scores are vital, they aren't the only factor lenders consider when evaluating your loan application.
3. Collateral or Assets
When getting a small-business loan, you'll likely need to bring something to the table, and that's usually collateral. This can include things like your business's equipment, real estate, or even inventory. If you can't make the loan repayments, the lender can claim these assets to recover the money lent.
Of course, there are also unsecured business loans that don't require physical collateral. However, they usually still need a personal guarantee. In some instances, lenders may choose to implement what's known as a blanket lien on your business assets. This type of collateral gives the lender the right to take over a wide range of business assets if you fail to repay the loan.
Consider SBA 7(a) loans. For amounts over $25,000, they generally call for collateral and a personal guarantee from anyone owning at least 20% of the business. In other words, if the company can't pay the loan back, these owners are on the hook to pay it from their assets.
Similarly, if a commercial bank is lending to a manufacturing business, it may ask for collateral in the form of machinery or equipment. If loan repayments stall, the bank can take over these assets to recover its money.
Navigating the business loan world can be tricky; each lender will have their own rules and requirements. Don't hesitate to ask for clarification if you're unsure about something. After all, understanding the ins and outs of your loan agreement is critical to making sure it's the right choice for your business.
4. Revenue and Profitability
Having a steady annual revenue is a critical factor funders look at when sizing up your business for business financing. They'll delve into your financial documents, like income statements, cash flow statements, balance sheets, and bank statements. This financial deep-dive helps funders gauge your business's health and your ability to pay back a loan.
For example, One Park Financial requires businesses to show an annual revenue of $90,000 to be eligible for business financing. Other lenders set their bars higher; online lender OnDeck requires a yearly income of $100,000 to qualify for its line of credit, while Bank of America asks for $250,000 for its secured business loans.
If these numbers seem out of reach for your business, don't worry! Alternative financing options, such as invoice factoring, can be more accessible for companies with lower revenues. These options can benefit newer or smaller businesses still growing their income.
Remember, the main goal is to show funders that your business is reliable and can repay a loan. Even if your revenue is lower than some lenders require, other avenues exist to secure that crucial funding for your business.
5. Debt-To-Income Ratio
Understanding your Debt-to-Income (DTI) ratio is vital when seeking a business loan. This ratio compares your monthly debt to your gross income, helping lenders assess whether you can manage additional debt.
You can calculate your DTI ratio by dividing your monthly debt by your gross income. For instance, if your business has a monthly debt of $10,000 and a gross income of $20,000, your DTI ratio is 50% ($10,000/$20,000).
A high DTI ratio may indicate higher risk to lenders, suggesting your business may struggle to handle additional debt repayments. While the acceptable DTI varies by lender, it's generally beneficial to keep your DTI at or below 43% to appear more favorable to potential lenders.
Consider another example: A business with a monthly debt of $5,000 and a gross income of $25,000 would have a DTI ratio of 20 ($5,000/$25,000). This lower ratio is more likely to be favorably viewed by lenders, as it suggests the business has a comfortable balance between debt and income.
To simplify this process, you can use online tools such as the Debt-to-income ratio calculator to calculate your DTI ratio. With this knowledge, you can better prepare your loan application, increasing your chances of approval.
Common Types of Business Loans
Now that you understand the standard requirements funders look at to decide whether you qualify for a loan or business financing. Let's familiarize ourselves with these seven popular types of business loans:
Term Business Loans
Term loans are a popular option for business owners needing substantial capital. They come with fixed repayment periods and interest rates, meaning you'll pay back your debt regularly over a specific time frame. Its predictability can make budgeting easier.
Small Business Administration (SBA) Loans
An SBA loan is a government-guaranteed loan provided by the U.S. Small Business Administration to support small businesses. These loans offer favorable terms and lower interest rates and are designed for business expansion, working capital, equipment purchases, or start-up costs. The downside? The application process can be lengthy and rigorous, requiring plenty of documentation and patience.
Business Line of Credit
A business line of credit works much like a credit card. You have a credit limit and can draw against it as needed. It offers flexibility in cash flow management and is usually used for short-term needs like purchasing inventory or covering operating expenses. Qualifying for a business line of credit financing often requires good credit and collateral.
Equipment Loans or Financing
This type of loan can be ideal if you need specific equipment to run your business. Lenders provide funds to purchase the equipment, which is collateral for the loan. The advantage is that you can finance up to 100% of the equipment's cost. It's most beneficial long-term if the equipment retains its value over the loan term.
Invoice Factoring
It involves selling your unpaid invoices to a factoring company for a percentage of their value. That way, you get cash upfront rather than waiting for customers to pay. It can help with immediate cash flow needs, but you will receive less than the total invoice value.
Invoice Financing
Similar to factoring, invoice financing allows businesses to use their unpaid invoices as collateral for a loan. The difference is that in financing, you're responsible for collecting invoice payments from your customers, and you get a more significant percentage of the invoice value upfront.
Revenue-Based Financing
Revenue-based financing lets a company receive upfront capital in exchange for a percentage of future revenues. It's typically repaid over a set period, with payments fluctuating based on your sales volume. A great option that can provide a quick influx of cash.
Like personal loans, navigating business loans can be tricky, but knowing your options will help you select the right fit for your needs. Do your research, consult with financial advisors, and understand the terms before you sign on the dotted line.
Borrowing responsibly is critical to avoid severe consequences like foreclosure, bankruptcy, or higher interest rates in the future. Always ensure you have a solid repayment strategy to maintain healthy finances for your business.
Fuel Your Business Growth with the Right Financing
Navigating the financial landscape can be challenging for small business owners. But with the right funding, you can unlock your business's full potential.
At One Park Financial, we're dedicated to helping businesses like yours thrive. If your company has been operating for at least three months and generates a minimum monthly revenue of $7,500, we can help.
Our team of experienced funding experts is here to guide you every step of the way. Don't let financial constraints hold you back. Apply now and see how One Park Financial can fuel your business's growth.
Disclaimer: The content of this post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. Please consult with your tax, legal, and accounting advisor before you begin any transaction.