A small business loan could be exactly what you need to start or grow your business. But it’s daunting. There are numerous requirements. And you may not be sure how to present your business in a way that gets a lender to agree to fund your needs.
Understanding a small business loan’s requirements upfront can demystify the process. Most businesses qualify for some loans. Qualifying comes down to numerous factors. That includes showcasing your business in the proper light. It’s not just about profits or years in the industry.
That’s why it’s so helpful to have a solid understanding of what lenders look for when considering applicants. This breakdown is what most lenders require for applicants. It gives you a good idea of how to present your company to win approval.
What does it mean to qualify for a business loan?
Qualifying for a business loan means your application meets the requirements. Qualification happens after you submit the documents requested, and an initial review confirms that those details seem to match the lender’s requirements.
Qualification does not mean you are approved. It means an initial review seems to show you have what it takes. Approval only happens once the lender goes through those details to verify them, and the underwriters agree to lend to you.
Every lender sets their own requirements. That includes different rules for each loan type, including both secured and unsecured loans. Every lender’s objective is to understand how much risk your business presents. They ultimately need to determine if you are likely to pay back your loan on time and within the agreed-upon terms.
What you present to a lender is critical. Be accurate, honest, and transparent. Make sure your business clearly demonstrates financial viability now and into the years to come.
Credit history lenders review when evaluating a business loan
Small business lenders consider numerous factors when deciding to lend. That includes the creditworthiness you demonstrate not just in your business transactions but in your personal history.
Lenders evaluate the creditworthiness of the owner and applicant in most cases. If you are a newer business, that may be the most critical factor. As your business grows and you start creating a business credit history, your company’s creditworthiness becomes a more dominant factor.
What’s the difference between personal and business credit?
Personal creditworthiness is dependent on your past use of credit, including mortgages, credit cards, and personal loans. Your personal Social Security number helps lenders track this when pulling a credit report.
Business credit looks at the company’s financial health, including any payment history on previous business loans, vendor payments, and secured loan repayments, such as the mortgage or lease on your business location. It tracks these details using your Employer Identification Number (EIN).
Both your personal and business creditworthiness determine if a lender believes lending to you is likely to lead to repayment. If there are questions about your ability to repay the debt based on past credit use, that will play a role in whether you can qualify for a loan.
Revenue and cash flow requirements for small business loans
Past loan experience is just one factor in qualifying for a small business loan. Lenders also need to consider whether you have a way of repaying the loan. To do that, they need to look at your current revenue and cash flow. That’s the money you already have coming in and your current ability to meet your financial obligations.
There is no standard minimum revenue requirement. It differs from one lender to the next and from one type of loan to another. However, all lenders will look at factors such as the following to understand the financial health and prospective financial well-being of your business:
- Revenue: The total amount of money a business earns from sales of its goods or services before subtracting any costs. Revenue shows what’s coming in.
- Profit: The financial gain achieved after subtracting the cost of operating your business from your total revenue. Profit only occurs when you have a positive balance after considering total costs and expenses. Profit indicates growth potential.
- Cash flow: The cycle of movement of money through the business, tracking both inflows, such as sales, and outflows, or expenses, over a period of time. Positive cash flow means your business has enough money to pay its bills on time, pay salaries, meet vendor requirements, and, if any is left over, pay debt obligations.
Lenders want to see what’s left after all of your expenses are accounted for throughout the month. This shows your repayment ability. If you do not have cash flow or profit to pay the added monthly cost of a loan payment, qualifying becomes much more challenging.
Time in business and operating history
Lenders also look at both your time in business and operating history to determine how likely it is for you to make payments on time.
Time in business is a risk signal. A new, unproven business may not have enough data to demonstrate there’s consumer demand or reliable revenue. Again, all lenders set their own rules, but the following gives you an idea of what they are looking for to qualify you to obtain a loan:
- Traditional banks: Lenders typically want to see 2 or more years in business.
- SBA-backed loans: Lenders typically prefer 2 or more years in business, but some will work with newer companies.
- Online lenders: They offer the most flexibility, with loans being a consideration if the business has 6 months to a year of operational history.
Newer businesses have fewer options. That doesn’t mean your new business cannot obtain a loan. You’ll need a more specialized loan to qualify.
Industry and business risk factors
Industry matters, too. Lenders look at trends within the industry, including demand, changing climate, and the economic viability of your business. Some industries are higher risk, especially if they are unproven to be long-term stable. There are some industries where lenders may have restrictions or that may be ineligible.
SBA eligibility is an important consideration here. For example, the SBA will not lend for passive real estate businesses, any type of multi-level marketing, speculative ventures, or high-risk sectors like gambling.
Business plans and loan purpose
The next factor lenders take into consideration is your business’s plans. A business plan provides clarity on several things, including:
- What your business does
- Who runs your business, and their qualifications
- Your competition and marketing placement
- How you advertise
A business plan is not always a requirement, though some lenders prefer to see it. It provides clarity on the overall strength of your business. If your business is a startup and you have yet to earn money from it, a business plan becomes an essential factor.
What is most important is that your business plan shows clear use of the funds you are requesting and how you expect to repay them. Demonstrate where the money will go and exactly how that supports the success of the company over the long term.
Collateral and personal guarantees
Collateral is some type of valuable asset that helps back up your borrowing. For example, if you own the building your business operates in, you may use the value of the building as collateral. That means, if you default on the loan, the value of the building can be used to repay what you owe. This is an example of a secured loan, one backed by assets.
Other loans are unsecured, meaning you do not have collateral behind the borrowed value. Lenders may still lend to you if you have strong creditworthiness, but you may pay more in terms of interest.
Note that a personal guarantee can be a valuable offer to show lenders that lending to you is a safe bet. Typically, it means that your personal assets are being used as collateral.
Documents you need to qualify for a business loan
Information is key here. Lenders will require not just statements about what you earn, but reports that show those details. Verification of your credit application will include looking at documents such as the following to ensure accuracy in what you’re reporting:
- Tax returns
- Financial statements, including profit and loss statements
- Bank statements
- Legal business documentation that shows ownership and legal establishment of your company
- Your personal identification and clarity on your role in the company
Requirements differ between lenders. You can expect traditional lenders to be more specific and exhaustive in these requirements than what you might expect from online lenders.
Preparing your business before applying for a loan
Being prepared with clear documentation improves credibility. Your lender can see that you are well aware of your business’s financial stance and have worked out the details. This reduces friction and delays. There are several critical steps to take if you have not done so before you apply for a loan:
- Legal business formation: Ensure your business is legally recognized, such as opening an LLC, demonstrating you’ve formed the business and your personal and business assets are separate.
- Articles of incorporation: This and other state-based requirements must be clearly defined.
- Financial accounts: EIN and established, separate business bank accounts.
- Records: Present all requested information to the lender. Be sure it is organized and easily understood.
Being prepared does not guarantee approval. It helps you demonstrate professionalism.
What to do if you don’t qualify right away
Denial or ineligibility for a new business isn’t that uncommon. However, it does create a clear path for you. You’ll likely know where your pain points are, such as improving your credit history or building a stronger financial base for your company.
Give yourself time, get your business structured and older, demonstrating revenue, and then consider reapplying later. Remember that qualifications can change over time.
Conclusion
Qualifying for a business loan is about knowledge, organization, and clarity, not about being perfect. Understanding the requirements lenders have before applying can help. When you start a new business, investing in it means showing lenders what you have to offer and convincing them that your business is financially sound.