Business Loan Requirements: 7 Things You Need to Qualify
Are you a small business owner considering taking out a loan? Getting a business loan can seem complex and time consuming — especially since every lender has their own specific business loan requirements. To help make the process easier, here’s an overview of seven common qualifications for business loans, so you’re better equipped to determine if you’re likely to qualify.
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1. Personal and business credit scores
When you apply for a small business loan, the lender will usually look at both your business and personal credit scores. Your credit score is like a report card that shows how responsible you are with money. The better your credit score is, the more likely it is that you will be approved for your loan and qualify for a competitive interest rate.
But, having bad credit doesn’t mean you won’t get approved for a business loan — you just might have to pay a higher interest rate or have to offer more collateral.
Personal credit scores
Personal credit scores are typically measured on a scale of 300 to 850. A score of 740 or higher is considered to be very good or excellent, while anything below 670 is generally considered fair or poor.
The easiest way to get your credit score for free is to check your recent credit card or loan statement, as many credit card companies and financial institutions now provide free credit scores for customers. If yours does, you may find your score on a statement or by logging into your account online. You can also go to AnnualCreditReport.com and get a free copy of your credit report from all three major reporting bureaus.
Business credit scores
Business credit scores are generally measured on a scale of 0 to 100. A score of 80 or higher is considered low risk, while anything below 50 is considered high risk.
When it comes to business credit scores, there are four main reporting agencies that provide them: Experian, Dun & Bradstreet, Equifax, and FICO’s Small Business Scoring Service (SBSS). These scores are usually calculated using a variety of factors, including your payment history, debt usage, industry and company size.
2. Annual revenue
When you borrow funds, lenders will often look at how much money your business makes in a year. This is because they want to make sure your business makes enough money to pay back the loan.
Many lenders look for businesses that have at least $100,000 in annual revenue. It’s important to note that some lenders may require less or more than this amount, so research lenders before applying to get a better understanding of the requirements.
Another metric lenders use to determine your capacity to take on a loan is your debt-to-income ratio, which measures how much of your monthly income goes toward paying off debt or other regular expenses.
For businesses, a similar metric lenders look at might be your fixed charge coverage ratio (FCCR). To calculate your fixed charge coverage ratio, you add your fixed earnings before interest and taxes (EBIT) to your fixed obligations before taxes. Then divide that total by the sum of your fixed charges before paying tax plus interest. Here it is expressed as a formula:
FCCR = (EBIT + fixed charges before taxes) / (fixed charges before taxes + interest)
As a general rule, an FCCR higher than 2 means your company is financially healthy and low risk, while an FCCR below 1 indicates you might have trouble meeting your financial obligations.
3. Time in business
Some lenders won’t approve loans from new or startup businesses. For example, many traditional brick-and-mortar banks require companies to be in business for at least two years to qualify for many of its loan and line of credit offerings.
However, even if you’re just starting out, startup business loans may be an option.
4. Business industry and size
In addition to revenue and time in business, lenders may have requirements regarding the size of your business. For example, the U.S. Small Business Administration (SBA) sets size standards for businesses in various industries and locations. These size standards vary depending on the type of industry and where a business is located.
For instance, the SBA will make loans to floor covering retailers with up to $9 million in gross receipts, but office supply and stationery retailers can have gross receipts up to $40 million and still qualify for an SBA loan.
5. Collateral or a personal guarantee
Lenders may also require collateral to approve you for a small business loan. Collateral is an asset you put up to secure the loan and reduce the risk for the lender. If you default on the loan, the lender can take your collateral.
The most common forms of collateral are real estate, equipment or machinery, inventory, and accounts receivable.
In some cases, lenders may require you to sign a personal guarantee, which means that if your business defaults on the loan, then you are personally responsible for paying it back. A personal guarantee puts your personal assets at risk if you don’t pay back the loan, so it’s important to understand what you are agreeing to before signing.
6. Business plan and funding request
When applying for a business loan, lenders will usually want to see some form of proof that you have a well-thought-out plan for how you’ll use the money and how you intend to pay it back. So you should be prepared with a business plan that includes an overview of how you’ll use the loan (such as expansion, equipment purchase or covering cash flow gaps), your current financial position and revenue projections.
Having a comprehensive funding request can help demonstrate that you’re prepared and ready to use the funds wisely.
7. Commonly required documents
In addition to the business loan requirements outlined above, most lenders look for additional documents when evaluating a loan application. These documents may include:
- Financial statements, including income statements and balance sheets, for the past three years
- Personal financial statements for you and your business partners
- 2+ years of personal and business tax returns
- Bank statements
- Copies of your Articles of Incorporation, Bylaws, or Operating Agreement
- Information on your collateral, such as a valuation on the real estate or an Accounts Receivable Aging report
Having these documents handy — and knowing how your business stacks up against these business loan requirements ahead of time — can help make the process of applying for a business loan smoother and less stressful.