Many people wait until they’re actually applying for a business loan before considering whether they’re eligible.
Since most businesses need finance at some stage of their life cycle, it’s worth understanding the basic criteria lenders are seeking.
We’ll explore how to qualify for a business loan, and the preparatory steps to give yourself the best chance of success.
How do Business Loan Requirements Work?
When a business applies for a loan, the lender’s main goal is to figure out how risky it would be to lend money to that business. To do this, they look at a range of information about the business and its owner. This includes their credit history, how well the business is doing financially, and their plans for using the loan.
The lender uses all this information to decide how likely it is that the business will be able to pay back the loan. If they think the risk is low, they’re more likely to approve the loan. If the risk seems high, they might not approve it, or they might offer the loan with a higher interest rate.
Typical Business Loan Eligibility
Business loan requirements vary depending on the lender, but they generally assess the borrower’s ability to repay the loan. This assessment is based on several key factors:
- Credit Score: Lenders often look at both personal and business credit scores to gauge the borrower’s creditworthiness. A higher credit score can increase the chances of loan approval and possibly result in more favourable loan terms.
- Business Plan: A well-structured business plan is crucial, especially for startups or small businesses. This plan should detail the business’s nature, the market it operates in, its financial forecasts, and how the loan will be utilised.
- Financial Statements: Lenders will review the business’s financial statements, including balance sheets, income statements, and cash flow statements, to understand its financial health and stability.
- Collateral: Some business loans are secured, meaning the borrower must provide assets as collateral. These could include property, inventory, or equipment. If the borrower defaults on the loan, the lender can seize the collateral.
- Business Experience and Performance: Lenders may assess the business owner’s experience in the industry and the business’s track record. A history of profitability and stable growth can be favourable factors.
- Debt-to-Income Ratio: This measures the business’s ability to manage and repay additional debt. A lower ratio is generally more favourable to lenders.
- Industry Type: Some industries are considered riskier than others. Businesses in stable, growing industries may find it easier to secure loans.
- Legal Documents: This can include business licenses, registrations, contracts, leases, and any other legal documents relevant to the business’s operation.
There are also likely to be some personal requirements, including:
- Personal Credit Score: A good personal credit history is important as it shows how you’ve handled debt in the past.
- Personal Financial Health: Your own financial situation, including your income and debts, is assessed.
- Personal Guarantees: You might need to agree to be personally responsible for the loan if your business can’t pay it back.
- Your Investment in the Business: Lenders often want to see that you have invested your own money in the business.
What Information is Needed for a Business Loan Application?
For a business loan application, the information you’ll typically need to provide includes:
- Your Personal Details: This includes your full name, contact details, and marital status.
- Business Information: Your business’s full name, address, contact phone number, and email address.
- Business Background: The type of industry you’re in and the date you started your business.
- Financial Information: Details about your business’s annual revenue.
- Personal Financial Details: Your personal bank account information and your personal income.
- Loan Amount and Purpose: How much funding you’re seeking and a clear plan for how you intend to use the loan.
Providing accurate and comprehensive information in these areas is crucial for the lender to assess your application effectively.
Common Business Loan Application Mistakes
Here are some of the most common business loan application mistakes to avoid:
- Inadequate Business Plan: A good business plan is essential. It should clearly outline your goals, market analysis, and financial forecasts, convincing lenders of your business’s potential.
- Insufficient or Inaccurate Documentation: Ensure all financial documents, including tax returns, financial statements, and bank statements, are complete and accurate. Missing or false information can cause delays or rejections.
- Misrepresenting Financials: Be honest about your business’s financial situation. Inflating numbers or hiding liabilities can backfire and damage your credibility.
- Ignoring Past Issues: Address any previous financial problems upfront. Lenders will likely uncover these in background checks, so being transparent shows integrity.
- Not Researching Lenders: Different lenders offer varied terms. Research to find the one that best suits your needs.
- Unprepared for Interviews: Be ready to discuss your business in detail during lender interviews. Show how the loan aligns with your goals.
- Unclear Loan Purpose: Know exactly why you need the loan. A clear purpose shows lenders that the funding aligns with your business plan.
- Not Ready for Negotiations: Be prepared to discuss loan terms. Knowing your financial position helps in negotiating better terms.
- Failing to Follow Up: After submitting your application, keep in touch with the lender. It shows you’re serious and engaged.
- Overlooking Alternative Funding: Consider other funding sources like crowdfunding or invoice factoring, which might be more suitable for your situation.
By avoiding these mistakes, you increase your chances of successfully securing a business loan.
Collateral requirements for business loans vary depending on the type of loan, the lender, and the borrower’s creditworthiness. However, in general, collateral is an asset that the borrower pledges to the lender in order to secure the loan. If the borrower defaults on the loan, the lender can seize and sell the collateral to recoup their losses.
Common types of collateral for business loans include:
- Real estate: This includes the borrower’s business property, such as the office building or warehouse.
- Business equipment: This includes machinery, vehicles, and other equipment that is essential to the borrower’s business operations.
- Inventory: This includes the borrower’s stock of goods that are ready for sale.
- Accounts receivable: These are unpaid invoices that the borrower has issued to its customers.
- Cash: This is the borrower’s liquid assets, such as money in the bank or cash on hand.
Lenders generally prefer collateral that is easy to value, liquid, and has a high resale value. For example, real estate is often a desirable form of collateral because it is difficult to hide or move, and it is relatively easy to sell in a market downturn. However, not all businesses have access to traditional forms of collateral. In these cases, lenders may accept other forms of collateral, such as personal guarantees from the borrower or the borrower’s spouse.
Other Options When You Don’t Meet Business Loan Requirements
If you find that you don’t meet the requirements for a traditional business loan, don’t be disheartened. There are alternative funding options available that might be better suited to your situation. These include:
1. Microloans: These are smaller loans often provided by non-profit organisations or government agencies. They’re designed for startups or small businesses that may not qualify for larger loans.
2. Crowdfunding: This involves raising small amounts of money from a large number of people, typically through online platforms. It’s a way to raise funds without the need for traditional lenders.
3. Angel Investors or Venture Capitalists: These are individuals or firms that invest in startups or small businesses in exchange for equity ownership. This can be a good option if you’re willing to share ownership of your business.
4. Merchant Cash Advances: If your business has a high volume of credit card sales, a merchant cash advance might be a possibility. This is where you receive a lump sum of money in exchange for a portion of your future credit card sales.
5. Invoice Factoring: This involves selling your accounts receivable (invoices) at a discount to a third party. It can be a quick way to get cash, but it’s generally more expensive than traditional loans.
6. Peer-to-Peer Lending: This is a method of debt financing that enables individuals to borrow and lend money without the use of an official financial institution as an intermediary.
7. Grants: Depending on your industry and business type, you might be eligible for government or private grants, which don’t need to be repaid.
8. Business Credit Cards: For short-term financing needs, a business credit card can be a viable option, though interest rates can be high.
Exploring these alternatives can provide the funding you need while you work on meeting the requirements for a traditional business loan.
Business Loan Requirements FAQ
What credit score is needed for a business loan?
The required credit score varies by lender, but generally, a score of 650 or higher is preferred. Some lenders may accept lower scores but may offer different terms.
How long does my business need to be operational to qualify for a loan?
Most lenders require your business to be operational for at least one to two years. However, startups might qualify for specific loan types or lenders.
Can I get a business loan with bad personal credit?
It’s challenging but not impossible. Some lenders may consider other factors like your business’s revenue and growth potential. You might face higher interest rates or stricter terms.
How important is my business’s annual revenue for loan approval?
Very important. Lenders use annual revenue to gauge your business’s health and ability to repay the loan. Each lender has different minimum revenue requirements.
Do lenders require a personal guarantee for a business loan?
Many lenders do require a personal guarantee, which means you’re personally liable for the loan if your business can’t repay it.
Are there any special loan requirements for online businesses?
The requirements are generally the same, but online businesses might need to provide additional information like website traffic, online sales data, and digital marketing strategies.